For this question,assume the interest parity conditions holds.Also assume that the domestic interest rate is 10% and that the foreign interest rate is 7%.Given this information,we would expect that
A)individuals will only hold foreign bonds.
B)individuals will only hold domestic bonds.
C)the domestic currency is expected to appreciate by 3%.
D)the domestic currency is expected to depreciate by 3%.

Question

Quizplus · Accepted Answer

According to interest rate parity, the difference between domestic and foreign interest rates should be equal to the expected change in the exchange rate. In this case, since the domestic interest rate is higher than the foreign interest rate, we would expect the domestic currency to depreciate to an extent that it offsets the interest rate differential. Therefore, the expected change in the exchange rate is (-3%), which means the domestic currency is expected to depreciate by 3%. As a result, individuals would prefer to hold foreign bonds to earn a higher return due to the higher interest rate and the expected appreciation of the foreign currency.

For This Question,assume the Interest Parity Conditions Holds