Final answer:
If a currency is expected to appreciate, its bond yields generally fall due to increased demand from foreign investors seeking higher returns, leading to a more affordable cost of borrowing for that country.
Step-by-step explanation:
When a country's currency is expected to appreciate in value, it often leads to a change in expected exchange rates and interest rates, which in turn, affects the yields on government bonds. If an exchange rate is undervalued and expected to rise, it implies that the currency will appreciate.
With the rise of the currency's value, foreign investments become more attractive due to a higher expected return when converted back into the investor's home currency.
Consequently, this increased demand can lead to a decrease in bond yields, as the country can now attract investors at a lower cost of borrowing.
If we consider two countries, where one has an undervalued currency that is expected to appreciate, and the other does not, the bond yields in the country with appreciating currency would likely fall while the other country's bond yields might rise or remain unchanged, depending on its own economic conditions.
Therefore, the correct answer is D. Undervalued currency's bond yield falls, other rises.