For the United States, suppose the annual interest rate on government securities
ID: 1194277 • Letter: F
Question
For the United States, suppose the annual interest rate on government securities equals 8 percent while the annual inflation rate equals 4 percent. For Japan, suppose the annual interest rate on government securities equals 10 percent while the annual inflation rate equals 7 percent. These variables would cause investment funds to flow from:
a.
The United States to Japan, causing the dollar to depreciate
b.
The United States to Japan, causing the dollar to appreciate
c.
Japan to the United States, causing the yen to depreciate
d.
Japan to the United States, causing the yen to appreciate
a.
The United States to Japan, causing the dollar to depreciate
b.
The United States to Japan, causing the dollar to appreciate
c.
Japan to the United States, causing the yen to depreciate
d.
Japan to the United States, causing the yen to appreciate
Explanation / Answer
c.
Japan to the United States, causing the yen to depreciate
Because real interest rates are higher in US as compared to Japan as shown below:
Real interest rate in united states = ((1+nominal rate) / (1+inflation)) -1 = 1.08/1.04 -1 =3.85%
Real interest rate in japan = ((1+nominal rate) / (1+inflation)) -1 = 1.10/1.07 -1 =2.80%
As real interest rate is higher in US, the investors will invest in US from Japan which will increase higher demand for dollar , thus yen will depreciate against dollar
c.
Japan to the United States, causing the yen to depreciate
Because real interest rates are higher in US as compared to Japan as shown below:
Real interest rate in united states = ((1+nominal rate) / (1+inflation)) -1 = 1.08/1.04 -1 =3.85%
Real interest rate in japan = ((1+nominal rate) / (1+inflation)) -1 = 1.10/1.07 -1 =2.80%
As real interest rate is higher in US, the investors will invest in US from Japan which will increase higher demand for dollar , thus yen will depreciate against dollar