Lecture 15

Question 1

Purpose of the UIP

Answer 1

Dictates the interaction between the nominal

exchange rate and the interest rate

Question 2

UIP condition equation

Answer 2

it − i∗t = (eEt+1 − et)et

interest rate gain (loss)
expected depreciation (appreciation)
i - domestic nominal IR
i*- foreign nominal IR
e - domestic nominal IR
e^E - expected domestic nominal IR

Question 3

Implications of the UIP

Answer 3

• Deposits in all currencies are equally desirable assets

- Arbitrage in the foreign exchange markets is not possible

Question 4

Under PAS Bh and Bf are perfect substitutes thus only two things influence the choice between them

Answer 4

i and i*

View about change in e: (eEt+1 - et)/ et