Suppose the domestic interest rate is 10%, the foreign interest rate is 12%, and the domestic currency is expected to appreciate by 4%. We should expect to see
A) a capital inflow and a reduction in the foreign interest rate
B) a capital inflow and a reduction in the domestic interest rate
C) a capital outflow and a reduction in the foreign interest rate
D) a capital outflow and an increase in the domestic interest rate
E) a capital outflow and an increase in the foreign interest rate

Question

Suppose the domestic interest rate is 10%, the foreign interest rate is 12%, and the domestic currency is expected to appreciate by 4%. We should expect to see
A)	a capital inflow and a reduction in the foreign interest rate
B)	a capital inflow and a reduction in the domestic interest rate 
C) 	a capital outflow and a reduction in the foreign interest rate
D)	a capital outflow and an increase in the domestic interest rate
E) 	a capital outflow and an increase in the foreign interest rate

Quizplus · Accepted Answer

Given the domestic interest rate is lower than the foreign interest rate, but the domestic currency is expected to appreciate, investors might find investing domestically more attractive due to the expected currency appreciation. This could lead to a capital inflow as investors seek to benefit from the appreciation, which in turn could reduce the domestic interest rate further due to increased supply of capital.

Suppose the Domestic Interest Rate Is 10%, the Foreign Interest