Inflation, interest rates, and exchange rates Relative inflation rates affect in
ID: 2771373 • Letter: I
Question
Inflation, interest rates, and exchange rates Relative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies. Consider the following statement: It companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be multiplied when the lending country's currency appreciates. Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid. The statement is valid, because as the currency of the lending country appreciates, it becomes cheaper to repay the initial loan and thus increase savings. The statement is invalid, because as the currency of the lending country appreciates, it becomes more expensive for the borrowing company to repay the initial loan. If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be by the losses from currency appreciation. The currency of a counter with a higher inflation rate than Japan's inflation rate will over time against the yen.Explanation / Answer
As per interest rate parity theorem , the country having lower interest rate shall have appreciated currency value in future. Because the demand for that countries current shall be high in future to repay the loans and interest value.
S0 it becomes more expensive for the borrowing co. to repay the initial loan.
Hence the given statement given is invalid.