Suppose that the U.S. interest rate is 5 percent and the Japanese interest rate is 1 percent. The effect of this difference in the foreign exchange market is that
A) financial capital stops moving.
B) a Japanese investor is guaranteed to make an additional 4 percent in yen terms by investing in the United States.
C) investors expect the yen to appreciate against the dollar.
D) investors expect the yen to depreciate against the dollar.

Question

Quizplus · Accepted Answer

When there is a difference in interest rates between two countries, investors tend to move their capital to the country with the higher interest rate, expecting to earn a higher return. However, this movement can lead to expectations of currency value changes. In this case, because the U.S. interest rate is higher than Japan's, investors might move their capital from Japan to the U.S. to gain higher returns. This capital movement can lead to an expectation that the yen will appreciate against the dollar, as demand for yen increases when investors eventually convert their dollars back to yen to repatriate their profits.

Suppose That the U