Exchange Risk and Corporate International Finance by Robert Z. Aliber (auth.)

By Robert Z. Aliber (auth.)

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Thus, if the domestic interest rate does not change as Ruthenia follows a more expansive monetary policy, even while the anticipated spot rate changes, then the spot rate must move immediately to its anticipated value, which is shown by trajectory 2. The adoption of the more expansive monetary policy leads to an immediate depreciation of the pengo from S 1 to S' 1; for some time thereafter, the spot rate remains constant. If the domestic interest rates increase as Ruthenia follows the more expansive policy, but by less than in the Fisherian model, the spot 40 Exchange Risk and Corporate International Finance exchange rate depreciates immediately to S' 1, and then depreciates along trajectory I.

In this way anticipations of changes in monetary policy might lead to changes in the spot exchange rate, even before the domestic price level changes. Hence the spot exchange rates might vary significantly as anticipations of monetary policy change and might differ from the levels suggested by Purchasing Power Parity. Conceivably there might be systematic differences between the predicted exchange rates and the observed exchange rates that cannot be explained by institutional factors like transactions costs and taxes.

S. inflation. The shift to floating rates reflects the erosion of the commitment to pegged rates, and the inability of the central bankers to set a new value for parities in which investors would have confidence. 3. Exchange Risk and Yield Differentials Changes in exchange rates are inevitable in a world of more than one hundred national currencies. Investors may be able to advance their economic welfare by acquiring assets denominated in currencies they expect to appreciate and selling assets and issuing liabilities denominated in currencies they expect to depreciate.

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