Suppose R R E e E E Then no investor would want to hold euro deposits driving

Suppose r r e e e e then no investor would want to

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– Suppose R $ > R + ( E e $/ E $/ )/ E $/ – Then no investor would want to hold euro deposits, driving down the demand and price of euros. – Then all investors would want to hold dollar deposits, driving up the demand and price of dollars. – The dollar would appreciate and the euro would depreciate, increasing the right side until equality was achieved: R $ > R + ( E e $/ E $/ )/ E $/ 3-54 effect of in interest rate? - rise in R USD (see Figure 3-5 ) - rise in R EUR (see Figure 3-6) effect of in expectations? - rise in E e USD/EUR (see Figure 3-6) explanation? see formula: expected USD return on EUR bonds = R EUR + expected appreciation of EUR Effect of changes? (p. 88)
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28 3-55 Dollar return R 2 $ R 1 $ Figure 3-­5 : Effect of a Rise in the Dollar Interest Rate Rates of return (in dollar terms) Exchange rate, E $ / 2 E 2 $ / 1' 1 E 1 $ / Expected euro return Interest Rates, Expectations, and Equilibrium 3-56 effect of in interest rate? - rise in R USD (see Figure 3-5) - rise in R EUR (see Figure 3-6 ) effect of in expectations? - rise in E e USD/EUR (see Figure 3-6) explanation? see formula: expected USD return on EUR bonds = R EUR + expected appreciation of EUR Effect of changes? (p. 88)
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29 3-57 Dollar return R $ Figure 3-­6 : Effect of a Rise in the Euro Interest Rate Rates of return (in dollar terms) Exchange rate, E $ / 1 E 1 $ / 2 E 2 $ / Rise in euro interest rate Expected euro return Interest Rates, Expectations, and Equilibrium 3-58 Source: The flying forint , The Economist , October 9, 2004 A real-life illustration
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30 3-59 Source: Japan s currency: carry on living dangerously , The Economist , February 10, 2007, p. 77. Another illustration 3-60 effect of in interest rate? - rise in R USD (see Figure 3-5) - rise in R EUR (see Figure 3-6) effect of in expectations? - rise in E e USD/EUR (see Figure 3-6 ) explanation? see formula: expected USD return on EUR bonds = R EUR + expected appreciation of EUR Effect of changes? (p. 88)
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31 3-61 Dollar return R $ = Figure 3-­6 : Effect of a Rise in the Euro Interest Rate Rates of return (in dollar terms) Exchange rate, E $ / 1 E 1 $ / 2 E 2 $ / Expected depreciation of dollar Expected euro return Interest Rates, Expectations, and Equilibrium 3-62 An example
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32 3-63 An example (2) 3-64 In the papers: October 9, 2014
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33 3-65 In the papers: October 9, 2014 Poland cut its main interest rate by a bigger than expected 50 basis points on Wednesday. Poland's first rate cut for 15 months, to a record low of 2 per cent, came after data exposed a slowdown in the country's industrial output and inflation. It was double the widely expected 25 basis point cut . 3-66 When the weather forecast calls for rain, people will carry umbrellas. That s just the illustration of how an expected likely-event influences behavior. In financial markets, the behavior of exchange rates… depends not only on the most likely future outcomes but also on possible, but less likely, outcomes .
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  • Fall '18
  • Leo van hove
  • Exchange Rate, Foreign exchange market, United States dollar

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