Question

Explain how expected changes in FX rates affects a decision to invest or borrow abroad.

Answer 1

If the domestic currency is expected to depreciate relative to the foreign currency

If the domestic currency is expected to depreciate relative to the foreign currency, investing abroad is better because the returns generated from the investment will be higher. This is because each unit of foreign currency fetches a higher quantity of domestic currency in the future.

If the domestic currency is expected to depreciate relative to the foreign currency, borrowing abroad is not good because the payments in domestic currency to repay the borrowing will be higher. This is because each unit of domestic currency fetches a lower quantity of foreign currency in the future.

If the domestic currency is expected to appreciate relative to the foreign currency

If the domestic currency is expected to appreciate relative to the foreign currency, investing abroad is not good because the returns generated from the investment will be lower. This is because each unit of foreign currency fetches a lower quantity of domestic currency in the future.

If the domestic currency is expected to appreciate relative to the foreign currency, borrowing abroad is better because the payments in domestic currency to repay the borrowing will be lower. This is because each unit of domestic currency fetches a higher quantity of foreign currency in the future.