2. Given expectations Ee of future exchange rates, when foreign interest rate fall significantly, investors will...

2. Given expectations E^e of future exchange rates, when foreign interest rate fall significantly, investors will ____ domestic assets, _____ domestic currency, ____ foreign currency, and _____ foreign assets.

A) sell; sell; buy; buy B) sell; buy; sell; buy

C) buy; sell; buy; sell D) buy; buy; sell; sell

Can you explain it in detail?

Expert Solution

Answer to the question:

Option d: Buy; Buy; Sell; Sell.
Explanation: We are well known to the theory of interest parity which states that say there are two countries A and B, a an investor will invest in a country where the expected interest rate is higher. Now, these investment inflow, in the country with higher interest rate , will tend to reduce the rate of interest since the invstment in the higher interest rate country will increase. This phenomenon is known as the Interest rate parity condition.Now, when the interest rate in the foreign nation tend to decline, the domestic investor will seel their foreign assets and in return they will obtain foreign currency. Now the investor will demand the domestic currency in return of the foreign currency and sell the foreign currency and buy domestic currency.

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Rahul Sunny answered 1 year ago

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