How will raise in interest rate impact currency valuation? I have read two contradictory information in CFA materials
Argument 1: IRP: Difference in interest rate will be reflected in value of the currency. For example, if US is offering 3% int and Eurozone is offering 5% interest, EUR will depreciate by 2% approx due to higher interest rate
Argument 2: Considering same interest rate as in argument 1, Euro will appreciate as more investors will invest in Eur and earn higher interest rates.
Can any of you please help me understand both these conflicting arguments?
There are many forces that affect exchange rates. Interest rate parity is one. Supply and demand is another. They generally pull in opposite directions.
Nothing conflicting in the arguments.
I am sorry, i don’t agree their. Probably, I wasn’t clear with my question. Let me put the reason why i came up with this confusion
I came across one question in Schweser Concept Checkers. The question was something like “Increase in interest rates will?”
a. appreciate currency value
b. depreciate currency value
c. no impact
I answered b considering IRP but I was wrong due to supply and demand. What should have been my answer here?
Your answer should be that it’s not possible to state conclusively either way. The forces work in opposition; I don’t know for certain which is greater. Do you?