Question

Using the concept of "carry trade," explain how a decrease in U.S. interest rates could affect the EUR/USD exchange rate. Given this change in exchange rate, how would firms and customers be affected?

professors note

Supply and demand for currencies can be tricky, not least due to the confusing idea that what we are buying or selling is money itself!

Once you can wrap your mind around the idea that money is what is being obtained for other money, the next set of questions relates to what would or could make the price of one money change in terms of another.

To this effect, I'd recommend a primer from Investopedia: Six Factors That Influence Exchange Rates.

For your consideration in responding to this post, I suggest reading on how the Carry Trade has the capacity to magnify systemic risk.

Answer 1

Carry trade is used as a conceptual trading Strategy where funds are borrowed in the market where the sates are low and invested back in the market where the interest rate is high Here, the different between these two rates, se earned as a profit for the trader. it also happens in the given scenario, where , funds will be withdrawn from the US market and supply of dollars will increas. it will cause USD to depreciate and Euro/Usb exchange rate will increase, as more USD is required to buy l Euro. It will fovour those firms who export their goods in the overseas market due to poice advantage in the international market But, it will hurt those firms who import as it will become more expensive. Customers who buy impsted goods, have to pay more dollar to get their impsited goods. so, they will also be negatively affected.