Question

Provide actual examples for each factor:
- Interest rate differentials
- Inflation rate differentials
- Country’s incoming level differentials
- Change in government controls such as international barriers
- Change in expectations of future exchange rates

Answer 1

Pt.1

Interest Rate Differentials refers to difference in interest rates between two securities. Example- When homebuyer borrows money to purchase houses there may be interest rate differential between the interest rate and bank's posted rate on prepayment date for loan/mortagages.

Pt.2

Inflation Rate Differential is difference in inflation rates between two countries which influences nominal exchange rate of countries. A Country with higher inflation rate would reduce value of money of that country resulting higher currrency exchange rate payment for import of goods and services from a country with lower inflation rates.

Pt.3

Country's incoming level differential refers to difference in earning(Yield) generated from similar investments. The popular example is Government Bond.

Pt.4

Change in Government Controls such as internataional barriers refers to relaxation in Government policies to facilitate international trade and Commerce. One example is change in Foreign Direct Investment rules

Pt.5

Change ind expectations of future exchage rate refers to exchage rate prediction based on economic growth potential. A country with strong economic environment tend to attract more foreign investments, thereby creating more demand for country's currency which appreciates value of currency.