Question

Under a fixed exchange rate​ regime, if there is a 25 percent chance a 25​% devaluation will occur in a months​ time, the financial markets will hold domestic bonds only if the central banks​ set:

A.a monthly interest rate 6.25​% lower than before.

B.a monthly interest rate 25​% higher than before.

C.an annual interest rate 25​% lower than before.

D.an annual interest rate 75​% higher than before.

In a fixed exchange rate​ regime, expectations that a devaluation may be coming can trigger an exchange rate crisis which the government may address by allowing a devaluation or trying to maintain the parity through interest rate changes. The problem with the second option​ is:

A. an increase in consumption.

B. an increased risk of recession.

C. a decrease to savings.

D. an increased risk of inflation

2) Given the interest parity condition, the demand for domestic bonds would ________(decrease, increase, or remain unchanged) if domestic interests rates decreased.

3) In a market where the domestic interest rate is 2.5​%, the foreign interest rate is 3.4​% and the current exchange rate is 95.00​,

the future expected exchange rate must be_____ for the interest parity condition to hold. ​(Round your response to two decimal​ places.)

Answer 1

Answer-A

A monthly interest rate 6.25 % lower than before,

$0.25(-20\%)=-6.25\%$

Answer-B

An increased risk of inflation

Due to the higher inflation, the prices of domestic goods increases leads to worsening the country's trade position. So the lowering the domestic rate of interest and government trying to estimate the devaluation using the interest parity condition.

Answer-C

Increase

It is because the bond holders can purchase more bonds with lower rate of interest.

Answer-D

73.52%

divide the foreign interest rate with the domestic interest rate