An economic principle suggests that if the annual interest rate on government bonds in Country A is 6% and in Country B is 2%, the currency of Country A should be expected to depreciate by approximately 4% against the currency of Country B over the next year. Now, suppose Country A's government introduces a new, strictly enforced law that prohibits foreign investors from purchasing any of its government bonds. How does this new law affect the expected relationship between the interest rates and the currency value?

Consider two countries with fully integrated financial markets, meaning investors can move funds between them without any cost or restriction. If the interest rate on a one-year government bond is 5% in Country A and 2% in Country B, this situation can only be a stable equilibrium if investors, on average, expect the currency of Country A to lose value relative to the currency of Country B over the next year. True or False?

Impact of Capital Flow Restrictions on Investment Decisions

Capital Controls and Interest Rate Differentials

An economic principle suggests that the difference in interest rates between two countries is offset by the expected change in their exchange rate. This principle relies on the ability of investors to move money freely. Match each of the following scenarios with its most likely impact on this principle.

The Role of Capital Mobility in International Finance

For the interest rate differential between two countries to be a reliable predictor of future exchange rate movements, investors must be able to act on that differential without restriction. This requires the absence of ______, such as taxes on foreign asset purchases or limits on the amount of currency that can be exchanged.

An investor notes that one-year government bonds in Country X offer a 7% annual return, while similar bonds in Country Y offer a 4% return. An economic principle suggests that this 3% difference should be offset by an expected 3% depreciation of Country X's currency relative to Country Y's currency over the year. Which of the following scenarios would most directly undermine the logic of this expected relationship?

An economic principle relies on the free movement of capital to ensure that a difference in interest rates between two countries is offset by an expected change in their exchange rate. Suppose the country with the higher interest rate suddenly prohibits its citizens from buying foreign assets. Arrange the following statements into a logical sequence that explains how this prohibition breaks down the economic principle.

Evaluating an Investment Strategy