Question

If a country’s currency is expected to appreciate in value, what would you think will be the impact of expected exchange rates on yields (e.g., the interest rate paid on government bonds) in that country?

Hint: Think about how expected exchange rate changes and interest rates affect a currency's demand and supply.

Answer 1

If a country's currency is expected to appreciate in value, the expected impact on exchange rates on yields in that country would be a logical process of lowering interest rates, because the currency, by increasing its value compared to the others, it would also increase their confidence in the international market. Thus, this would imply that rates would decrease given the greater confidence and stability that this currency would provide the market.