# Reading 27 - Problem 3 B

Can someone explain me or point me into the right LOS, that explains how a “a weak currency usually goes with rising interest rates (and negative bond market return”) Relates to Reading 27, Problem 3-B, Page 391. Thanks

Based on IRP… F1=S0 * (1+Rdc)/(1+Rfc) where S0 is in DC/FC so if we take an example: S0 = 1.5 /Euro r = 4% rEuro = 5% F = 1.5 * 1.04 / 1.05 --> 1.4857 \$/Euro so USD has appreciated, Euro has depreciated (Since it can only buy fewer USD now). Rate increased - currency weakened… and once rate increases - bond market returns would be lower - since the bond prices would go down…

Had the same question but not sure I “get it” given the above response. So we are saying … IRP relates exchange rates and interest rates and here we are just making an additional step to say that since we know interest rates will rise when a currency weakens–to maintain that no-arb condition–we can also say that the correlation between the bond market and the exchange rate will be positive? Assuming I didn’t botch the above, what can we say about question 2 which shows a negative correlation? What say ye?