Question

In: Economics

Assume that investors have a choice between purchasing foreign bonds or domestic bonds. Why does exchange...

Assume that investors have a choice between purchasing foreign bonds or domestic bonds. Why does exchange rate volatility cause countries to attempt to keep their interest rates in line with the interest rates of other countries.

Solutions

Expert Solution

The investors have a choice between purchasing foreign bonds or domestic bonds. In this case exchange rate volatility cause countries to attempt to keep their interest rates in line with the interest rates of other countries.
Investors are making the choices because of the following reasons:
In the domestic bonds the fluctuation rate is very high in comparison to the foreign bonds.
Domestic bonds are based on the local factors and in the foreign bonds various global factors are responsible for the settlement of the prices.
The stability in the foreign bonds is higher than the domestic bonds.
The rate of growth is higher in the foreign bonds in comparison to the domestic bonds.
The exchange rate volatility cause countries to attempt to keep their interest rates in line with the interest rates to other countries because of the following reasons:
The change in interest rate will change the expected returns for the investors.
The change in interest rate is very important to maintain the returns at the stable rate.


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