Agoodassumptiontomakefortheshortrun the demand of

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Unformatted text preview: The Demand of Currency Deposits (cont.) (cont.) Rate of return: the percentage change in value that an asset offers during a time period. – The annual return for $100 savings deposit with an interest rate of 2% is $100 x 1.02 = $102, so that the rate of return = ($102 ­ $100)/$100 = 2% Real rate of return: inflation­adjusted rate of return, – which represents the additional amount of goods & services that can be purchased with earnings from the asset. – The real rate of return for the above savings deposit when inflation is 1.5% is: 2% – 1.5% = 0.5%. After accounting for the rise in the prices of goods and services, the asset can purchase 0.5% more goods and services after 1 year. The Demand of Currency Deposits (cont.) (cont.) If prices are fixed, the inflation rate is 0% and (nominal) rates of return = real rates of return. Because trading of deposits in different currencies occurs on a daily basis, we often assume that prices do not change from day to day. – A good assumption to make for the short run. The Demand of Currency Deposits (cont.) (cont.) Risk of holding assets also influences decisions about whether to buy them. Liquidity of an asset, or ease of using the asset to buy goods and services, also influences the willingness to buy assets. But we assume that risk and liquidity of currency deposits in foreign exchange markets are essentially the same, regardless of their currency denomination. – Risk and...
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