Perfect asset substitutability is the assumption that
A) the foreign exchange market is in equilibrium only when expected returns on domestic assets are greater than returns on foreign currency bonds.
B) the foreign exchange market is in equilibrium only when expected returns on foreign currency bonds are greater than returns on domestic assets.
C) the foreign exchange market is in equilibrium only when expected returns on all assets are negative.
D) the foreign exchange market is in equilibrium only when expected returns on domestic assets are equal to returns on foreign currency bonds.
E) the foreign exchange market is in equilibrium only when domestic assets are risk-free.

Question

Quizplus · Accepted Answer

Perfect asset substitutability assumes that investors can freely switch between domestic assets and foreign currency bonds at no cost, meaning that the expected returns on both types of assets must be equal in order for the foreign exchange market to be in equilibrium. Therefore, the correct answer is D, which states that the market is in equilibrium only when expected returns on domestic assets are equal to returns on foreign currency bonds.

Perfect Asset Substitutability Is the Assumption That