Exchange rates and the Foreign Exchange Market: An Asset Approach - Equilibrium in the Foreign Exchange Market
3 important questions on Exchange rates and the Foreign Exchange Market: An Asset Approach - Equilibrium in the Foreign Exchange Market
Foreign exchange market in equilibrium:
When market participants willingly hold the existing supplies of deposits of all currencies. (this is because deposits of all currencies offer the same expected rate of return)
Interest parity condition
The condition that the expected returns on deposits of any two currencies are equal when measured in the same currency. (there is no excess supply of some type of deposit and no excess demand for another).
The influence of depreciation and appreciation on expected returns
- Depreciation of a country's currency today lowers the expected domestic currency return on foreign currency deposits.
- Appreciation of the domestic currency today, raises the domestic currency return expected of foreign currency deposits.
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