Question #4: According to the Portfolio Balance Model, if there is an increase i

Question

Question #4: According to the Portfolio Balance Model, if there is an increase in domestic interest rates what happens to the following (increase, decrease, or remain the same) assuming a flexible exchange rate system? a. Demand for domestic bonds b. Demand for foreign bonds c. Value of the domestic currency Question #5: According to the Portfolio Balance Model, how are the following items are affected ( increase, decrease, or remain the same)? a. Demand for money when wealth increases b. Demand for domestic bonds when expected appreciation of the foreign currency occurs c. Demand for foreign bonds when risk premium should increase

Explanation / Answer

4) a) With domestic interest rate more than foreign rate, the demand for domestic bonds increases as they give a higehr return.

b) The demand for foreign bonds decreases as the lower interest in foreign reduces its returns.

c) There will be large inflow of capital which will lead to appreciation of the domestic currency.

5) a) Increase in wealth causes increase in demand for money as the individual has more funds to allocate between bonds and money holdings

b) With expected appreciation of foreign currency or depreciation of domestic currency, there will be large capital outflow. The donestic interest rate will be lower than foreign rate of interest and the demand for domestic bonds will decrease due to its lower returns.

c) Demand for foreign bonds will increase as it compensates for the risk taken by the way of increasing the risk premium.

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---