Assume that the interest parity condition holds and that individuals expect the Australian dollar to appreciate by 5% during the coming year. Given this information, we know that: A) i i*. B) the interest rate differential between the two countries is less than 5%. C) i

Question

Assume that the interest parity condition holds and that individuals expect the Australian dollar to appreciate by 5% during the coming year. Given this information, we know that:
A) i > i*.
B) the interest rate differential between the two countries is less than 5%.
C) i < i*.
D) individuals will only hold foreign bonds.
E) i = i*.

Quizplus · Accepted Answer

If individuals expect the Australian dollar to appreciate by 5%, then they will be willing to accept a lower interest rate on an Australian bond compared to a foreign bond. This means that i (interest rate on Australian bond) will be lower than i* (interest rate on foreign bond). Hence, the correct choice is C.

Assume That the Interest Parity Condition Holds and That Individuals