Question #35
Reading: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value
PDF File: Reading 5 Currency Exchange Rates - Understanding Equilibrium Value.pdf
Page: 14
Status: Unattempted
Correct Answer: A
Question
Given currency quotes in DC/FC, if: 1 + rDC < (1 + rF
Answer Choices:
A. flow out of the domestic country
B. flow into the domestic country
C. flow in and out of the domestic country
Explanation
This equation is Interest Rate Parity rearranged! If the term on the left (1 + rDC), is less
than the term on the right, it means that the domestic rate is low relative to the hedged
foreign rate. Therefore, there is a profitable arbitrage from borrowing the domestic
currency and lending at the foreign interest rate. Because we lend in the foreign market,
we say that the funds flow out of the domestic economy.