Assume that the interest parity condition holds. If the domestic interest rate is 12% and the foreign interest rate is 9% then given this information, we would expect that:
A) the foreign currency is expected to depreciate by 3%.
B) the domestic currency is expected to depreciate by 3%.
C) individuals will only hold foreign bonds.
D) individuals will only hold domestic bonds.
E) the domestic currency is expected to appreciate by 3%.

Question

Quizplus · Accepted Answer

According to the interest parity condition, the difference in interest rates between two currencies should equal the expected change in the exchange rate between them. In this case, the domestic interest rate is higher than the foreign interest rate by 3%, so we would expect the domestic currency to depreciate by 3% to offset the higher interest rate and maintain the interest parity condition.

Assume That the Interest Parity Condition Holds