Imagine you are a German investor trying to decide whether to buy American or European bonds. A ten-year bond issued by America’s Treasury today offers about 3%; German bonds return only 1.2%. But buying American means taking a gamble on the euro-dollar exchange rate. You are interested in the return in euros. The bond issued in the US will be attractive only if the extra yield exceeds any expected loss due to swings in currency markets. This thinking explains why the dollar has recently soared against the euro. In July 2022 the dollar reached a one-for-one exchange rate with the euro for the first time since 2002. Is it always true that a currency appreciates in value when the interest rate it offers increases relative to foreign interest rates? Explain.

Imagine you are a German investor trying to decide whether to buy American or European bonds. A ten-year bond issued by America’s Treasury today offers about 3%; German bonds return only 1.2%. But buying American means taking a gamble on the euro-dollar exchange rate. You are interested in the return in euros. The bond issued in the US will be attractive only if the extra yield exceeds any expected loss due to swings in currency markets. This thinking explains why the dollar has recently soared against the euro. In July 2022 the dollar reached a one-for-one exchange rate with the euro for the first time since 2002. Is it always true that a currency appreciates in value when the interest rate it offers increases relative to foreign interest rates? Explain.

Economics:

10th Edition

ISBN:9781285859460

Author:BOYES, William

Publisher:BOYES, William

Chapter36: Exchange Rates And Financial Links Between Countries

Section: Chapter Questions

Problem 18E

See similar textbooks

Similar questions

Suppose the interest rate is 7% on euro-denominated assets of a one year maturity and 5 percent on a dollar-denominated assets of a one-year maturity, and the current spot exchange rate for the euros in terms of the dollars is $1.50/€ . If the dollar is expected to appreciate at 4 percent rate, what is the rate of return that a French investor can expect to earn on a dollar-denominated assets? 3% 1% 5% 11%
Byron converted $1,000 to ¥105,000 for a trip to Japan. However, he spent only ¥50,000. During this period, the value of the dollar weakened against the yen. Using a current exchange rate of $1 = ¥100, how many dollars does Byron have left? The Simpson Group converts $1,000,000 into euros when the exchange rate is $1 = €0.75. After three months, the company converts this back into dollars when the exchange rate is $1 = €0.80. What is the outcome of this transaction? There Today, a U.S. shipping company, imports industrial packaging from Japan. The company must pay in yen to the Japanese supplier within 30 days. In a particular exchange, the company must pay the Japanese supplier ¥150,000 for each set of industrial packaging at the current dollar/yen spot exchange rate of $1 = ¥110. There Today intends to resell the packaging the day they arrive for $1,600 each but it does not have the funds to pay the Japanese supplier until these have been sold. What will happen if the…
Evaluate how demand and supply in Jamaica affect and determine the country's foreign exchange rate in 290 words.
Explain how each of the following transactions generates two entries–a credit and a debit–in the Japanese balance of payments accounts, and describe how each entry would be classified: a. A Japanese investor buys a share of a stock company in Thailand, paying by writing a check on an account with a Singapore bank. Second, a Japanese investor buys a share of a Thai stock company, paying the seller with a check on a Japanese bank. Third, a Japanese-owned factory in Germany uses local earnings to buy additional machinery. b. The Malaysian government carries out an official foreign exchange intervention in which it uses yen held in a Japanese bank to buy ringgit (Malaysian currency) from its citizens. c. A tourist from Kyoto buys a meal at an expensive restaurant in Bangkok, paying with a traveler’s check.
Suppose you are a British venture capitalist holding a major stake in an e-commerce start-up in Silicon Valley. As a British resident, you are concerned with the pound value of your U.S. equity position. Assume that if the American economy booms in the future, your equity stake will be worth $901, and the exchange rate will be $1.28/£. If the American economy experiences a recession, on the other hand, your American equity stake will be worth $817, and the exchange rate will be $1.43/£. You assess that the American economy will experience a boom with a 50 percent probability and a recession with the remaining probability.Estimate the expected value of the property in GBP (as XXX.XXX)
Suppose that the current exchange rate is 1.50 = £1, but it is expected to be 1.35 = £1in one year. If the current interest rate on a one-year government bond in the United Kingdom is 4%, what does the interest-rate parity condition indicate the interest rate will be on a one-year government bond in Germany? Assume that there are no differences in risk, liquidity, taxation, or information costs between the bonds.
Because Vin’s receives payments in British pounds every month and converts those pounds into euros, it needs to closely monitor the value of the British pound in the future. David Hewson, owner of Vin’s, expects that inflation will rise substantially in the UK, while inflation in Ireland will remain low. He also expects that the interest rates in both countries will rise about the same amount. a. Given David’s expectations, forecast whether the pound will appreciate against the euro over time. b. Given David’s expectations, will Vin’s be favourably or unfavourably affected by the future changes in the value of the pound
Given the following data: R = $1.00/Y100 F = $1.00/Y95 i u.s. = 5%. If the interest parity condition is expected to hold, interest rates in Japan (Japan) should equal % (enter your answer as a percentage rounded to two decimal places).
Assume that interest rate parity holds. In both the spot market and the 90-day forward market, 1 Japanese yen equals 0.0094 dollar. In Japan, 90-day risk-free securities yield 4.6%. What is the yield on 90-day risk-free securities in the United States?
PQ 7 In the portfolio balance model, other things equal, an increase in the home country wealth because of a current account surplus will: a. reduce home country demand for money b. reduce home country demand for foreign bonds c. have an intermediate effect on the domestic interest rate (without more information) d. not affect the domestic demand for either foreign or domestic bonds.
If the exchange rate at time t is €1/$. You invest $1 in an euro asset at t, which has an interest of 8%. If the exchange rate at time t+1 is €1.02/$, then your rate of return in terms of $ is %
Under the pure flexible exchange rate regime, if a country runs a deficit on the overall balance (the combined balance on the current, capital, and financial accounts is negative), the central bank of the country can supply foreign exchanges out of its reserve holdings.True or false