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Question 1  Please help awnser the following question I have attached pictures of the a small context into UIP and a possible expalantion For each question, say whether the statement is true or false, and give a short explanation for your answer, with a diagram or example if needed.  1. Assume that uncovered interest rate parity holds. If country A has an interest rate of 10% and country B has an interest rate of 15%, then we would expect country B’s currency to appreciate with respect to country A’s. You should include a formula in your explanation.

Question 1  Please help awnser the following question I have attached pictures of the a small context into UIP and a possible expalantion For each question, say whether the statement is true or false, and give a short explanation for your answer, with a diagram or example if needed.  1. Assume that uncovered interest rate parity holds. If country A has an interest rate of 10% and country B has an interest rate of 15%, then we would expect country B’s currency to appreciate with respect to country A’s. You should include a formula in your explanation.

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
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Question 1 

Please help awnser the following question I have attached pictures of the a small context into UIP and a possible expalantion

For each question, say whether the statement is true or false, and give a short explanation for
your answer, with a diagram or example if needed. 


1. Assume that uncovered interest rate parity holds. If country A has an interest rate of 10%
and country B has an interest rate of 15%, then we would expect country B’s currency to
appreciate with respect to country A’s. You should include a formula in your explanation.

Why Would UIP Hold? • Why would be expect investors to be indifferent between US and European bonds? • Suppose it turned out that the European bonds offered a better deal than the US bonds. • If there is perfect capital mobility, then this would mean that there would be a rush for investors to purchase European bonds rather than US bonds. • European institutions who borrow via selling these bonds (governments, highly rated corporations) would figure out that they could borrow at a lower interest rate and still find investors willing to buy their bonds as well as US bonds. • By this logic, deviations from UIP should be temporary with borrowers adjusting the interest rates on their bonds to ensure that investors are indifferent between various international investments.
Transcribed Image Text:Why Would UIP Hold? • Why would be expect investors to be indifferent between US and European bonds? • Suppose it turned out that the European bonds offered a better deal than the US bonds. • If there is perfect capital mobility, then this would mean that there would be a rush for investors to purchase European bonds rather than US bonds. • European institutions who borrow via selling these bonds (governments, highly rated corporations) would figure out that they could borrow at a lower interest rate and still find investors willing to buy their bonds as well as US bonds. • By this logic, deviations from UIP should be temporary with borrowers adjusting the interest rates on their bonds to ensure that investors are indifferent between various international investments.
Uncovered Interest Parity • The last equation can be re-written as Etet+1 - et Etet+1 1 + i + et et • Subtracting the 1 from each side, we get Etet+1 - et et Etet+1 et i+ = it' et Etet+1-et Since both i and et are going to be relatively small, the product of them will usually be close to zero, so the condition for the investor to be indifferent between the two investment strategies is Etet+1 et US + et • This condition which says that the foreign interest rate plus the expected percentage change in the value of the foreign currency should equal the domestic interest rate-is known as the Uncovered Interest Parity condition. • If European interest rates are lower than US rates, then the Euro must be expected to appreciate. - et - - US 1+ius :US
Transcribed Image Text:Uncovered Interest Parity • The last equation can be re-written as Etet+1 - et Etet+1 1 + i + et et • Subtracting the 1 from each side, we get Etet+1 - et et Etet+1 et i+ = it' et Etet+1-et Since both i and et are going to be relatively small, the product of them will usually be close to zero, so the condition for the investor to be indifferent between the two investment strategies is Etet+1 et US + et • This condition which says that the foreign interest rate plus the expected percentage change in the value of the foreign currency should equal the domestic interest rate-is known as the Uncovered Interest Parity condition. • If European interest rates are lower than US rates, then the Euro must be expected to appreciate. - et - - US 1+ius :US
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