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

This preview shows page 27 - 34 out of 51 pages.

– 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)
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)
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
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)
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
32 3-63 An example (2) 3-64 In the papers: October 9, 2014
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 .

#### You've reached the end of your free preview.

Want to read all 51 pages?

• Fall '18
• Leo van hove
• Exchange Rate, Foreign exchange market, United States dollar

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern