For those of you studying with the Schweser Notes, this is on page 198 of the Econ book.
The question is:
- An increase in the policy rate will most likely lead to an increase in:
A. business investment in fixed assets
B. consumer spending on durable goods
C. the foregin exchange value of the domestic currency
Through process of elimination, it can be deduced that the answer is C since business investment and spending on durable goods will go down due to higher interest rates, which leaves us with C.
However, I’m not really sure why answer C, by itself, is correct, without using process of elimination.
The explanation says that the increase in longer-term interest rates will make investments in the domestic economy more attractive to foreign investors, increasing demand for the domestic currency and causing the currency to appreciate.
Why does this increase lead to more attractive domestic investment for foreigners?? In other words, how does having higher interest rates affect whether or not foreigners want to invest?
they receive more value for the money invested in your country (more than they might get in their own country).
Interest received on money invested …
What cpk123 said…
If you personally could get interest rates of 10% in a foreign country whereas in the UK or US your interest is only 0.5%. Where would you move your money?..probably to the foreign country.
As a result, demand for that currency increases, and with increased demand comes an appreciation in the currency value.
hope this helps.
Thanks guys. Makes sense. I was overthinking and kept thinking “investments” as in “equities, etc”.
I know what you’re trying to say but one thing: I don’t think you can compare 10% to 0.5% directly without considering exchange rates. Am I correct? For example, 10% ¥ may or may not be the same as 0.5% USD.
I am a Japan investor - invested 10 M Yen into a US project (investment) and will get 10% returns in Yen - that is all I need.
Forget that a conversion happened between Yen to USD ever. That Exchange rate risk can be hedged (And you will learn about this later in L3 - you bought a USD investment - so you would sell a Yen-USD Forward contract - to assure a return in Yen which is equal to the risk free rate).