Therefore, according to the uncovered interest parity condition, the domestic interest rate should be equal to the foreign interest rate (r*). If the domestic interest rate were higher than the foreign interest rate, investors would buy the domestic currency to take advantage of the higher interest rate, which would put upward pressure on the domestic currency and violate the fixed exchange rate.

From the covered interest parity, we know that when the forward premium for the home currency against a foreign currency, F(home/foreign), is positive, the domestic interest rate should be: Question 2 Answer a. less than the foreign interest rate. b. greater than the foreign interest rate. c. less than the forward premium. d. greater than the forward premium.

Assume the interest parity condition holds and that the foreign interest rate is equal to the domestic interest rate. A reduction in the foreign interest rate will causeGroup of answer choicesa decrease in the nominal exchange rate.an increase in the nominal exchange rate.an expected appreciation of the domestic currency.none of the above

. Consider an economy with a fixed exchange rate, S. Through the problem, assume that the foreign interest rate, r ∗ , remains constant. (a) Suppose that financial market participants believe that the government is committed to a fixed exchange rate. What is the expected exchange rate? According to the (uncovered) interest parity condition, what is the domestic interest rate?

Which of the following statement(s) is (are) TRUE?Select one or more alternatives:Investing in a country with a higher interest rate does not secure higher returns because the currency in a high-interest-rate country is expected to depreciate and reduce the profit.The law of one price means that the return from a dollar invested in home currency should be equivalent to the return from a dollar invested in foreign currency together with a long home currency forward contract, if the covered interest rate parity (CIP) condition holds.If the uncovered interest rate parity (UIP) condition holds then it is possible to profit using a carry trade (by borrowing in a low interest rate currency and investing in a high interest rate currency).Forward rate is an unbiased predictor of future spot rate if covered interest rate parity condition holds.

Suppose that financial market participants feared a devaluation, as in part (b), and a devaluation actually occurs. The government announces that it will maintain a fixed exchange rate regime but changes the level of the fixed exchange rate to S ′ , where S ′ > S. Suppose that financial market participants believe that the government will remain committed to the new exchange rate, S ′ , and that there will be no further devaluations. What happens to the domestic interest rate after the devaluation?