Unformatted text preview: return with the rate of return from a dollar deposit.
– The rate of return is simply the interest rate.
– After 1 year the $100 is expected to yield $102: ($102$100)/$100 = 2% The euro deposit has a lower expected rate of return: thus, all investors should be willing to dollar deposits and none should be willing to hold euro deposits. The Demand of Currency Deposits
(cont.) Note that the expected rate of appreciation of the euro was ($0.97 $1)/$1 = 0.03 = 3%.
We simplify the analysis by saying that the dollar rate of return on euro deposits approximately equals – the interest rate on euro deposits – plus the expected rate of appreciation of euro deposits – 4% + 3% = 1% ≈ 0.88%
– R€ + (Ee$/€ E$/€)/E$/€ The Demand of Currency Deposits
The difference in the rate of return on dollar deposits and euro deposits is R (R + (Ee E )/E ) =
$/€ R$ expected rate
of return =
deposits R€ (Ee$/€ E$/€)/E$/€ interest rate
exchange rate current
exchange rate expected rate of
appreciation of the euro expected rate of return on euro deposits Table 13-3: Comparing Dollar
Rates of Return on Dollar and Euro
Deposits Model of Foreign Exchange
Markets We use the – demand of (rate of return on) dollar denominated deposits – and the demand of (rate of return on) foreign curr...
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