Using the UIP equation, what would happen to the spot rate for euros if the interest rate on U.S. dollar deposits rises, ceteris paribus?
A) The spot rate to purchase euros would rise (dollar depreciation).
B) The spot rate to purchase euros would fall (dollar appreciation).
C) The spot rate to purchase euros would be unchanged.
D) The U.S. Federal Reserve would have to raise U.S. short-term interest rates.

Question

Quizplus · Accepted Answer

According to the UIP equation, an increase in the interest rate on U.S. dollar deposits would increase expected returns on dollar-denominated assets, making them relatively more attractive to investors. As a result, demand for euros would fall, leading to a decrease in the spot rate to purchase euros (dollar appreciation).

Using the UIP Equation, What Would Happen to the Spot