what is the relationship between interest rates and exchange rates. All other variables held constant. Example - If interest rates in country A is 10% and interest rate in country B is 5%. What will be the impact on the exchange rates if interest rates in Country A goes up to 15% and interest rate in country B decreases to 3%. Please state whether currency of country A will depreciate or appreciate against that of country.
I dont understand much of the question. But relatively if int rates decrease, you’d see weakening currency.
pepp Wrote: ------------------------------------------------------- > I dont understand much of the question. But > relatively if int rates decrease, you’d see > weakening currency. That’s only in the short term. Since (assuming that) real interest rates are the same around the world, nominal interest rates differences are only due to inflation differences. Based on relative PPP, you would expect contries with higher inflation (i.e. higher interest rates) to see their currencies depreciate. If you want to see how the short term and the long term effects fit together, you can look at the J-curve (it was part of portfolio management in last year (june 2008)'s Level 2 curriculum)
zombie7e7 Wrote: ------------------------------------------------------- > what is the relationship between interest rates > and exchange rates. All other variables held > constant. > > Example - If interest rates in country A is 10% > and interest rate in country B is 5%. What will be > the impact on the exchange rates if interest rates > in Country A goes up to 15% and interest rate in > country B decreases to 3%. Please state whether > currency of country A will depreciate or > appreciate against that of country. Based on relative PPP (and Fisher), Country A’s currency will depreciate against that of country B’s currency.
Higher interest rates usually indicates higher inflation meaning that things are becoming expensive faster, which in turn means reduced purchasing power.