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Supposetheinterestrateonaeurodepositis4

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Unformatted text preview: liquidity are only of secondary importance when deciding to buy or sell currency deposits. – Importers and exporters may be concerned about risk and liquidity, but they make up a small fraction of the market. The Demand of Currency Deposits (cont.) (cont.) We therefore say that investors are primarily concerned about the rates of return on currency deposits. Rates of return that investors expect to earn are determined by – interest rates that the assets will earn – expectations about appreciation or depreciation The Demand of Currency Deposits (cont.) (cont.) A currency deposit’s interest rate is the amount of a currency that an individual or institution can earn by lending a unit of the currency for a year. The rate of return for a deposit in domestic currency is the interest rate that the deposit earns. To compare the rate of return on a deposit in domestic currency with one in foreign currency, consider – the interest rate for the foreign currency deposit – the expected rate of appreciation or depreciation of the foreign currency relative to the domestic currency. The Demand of Currency Deposits (cont.) (cont.) Suppose the interest rate on a dollar deposit is 2%. Suppose the interest rate on a euro deposit is 4%. Does a euro deposit yield a higher expected rate of return? – Suppose today the exchange rate is $1/€1, and the expected rate one year in the future is $0.97/€1. – $100 can be exchanged today for €100. – These €100 will yield €104 after one year. – These €104 are expected to be worth $0.97/€1 x €104 = $100.88 in one year. The Demand of Currency Deposits (cont.) (cont.) The rate of return in terms of dollars from investing in euro deposits is ($100.88­$100)/$100 = 0.88%. Let’s compare this rate of...
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