5 points Suppose the markets change their expectations of th

.5 points. Suppose the markets change their expectations of the future value of the dollar, such that they expect it to be stronger ot that time in the future than their expectation was previously lie, E How would this change in expectations affect spot exchange rates assuming interest rates stay constant? What would the central bank have to do to keep the spot rate from changing? a) b) ot 2 700 Words Engsh (us Focus

Solution

a) Future value of any currency largely depends on two factors; Spot Rate and Interest Rate. In the given scenario, since the interest rate is expected to stay constant, it is spot rate which is driving the expectations about future value to be higher. That clearly implies that spot rate of dollar will appreciate.

b) The central bank has to increase the interest rate, if it wishes to keep a check on spot rate increase. This will neutralize the impact on spot rate from stronger future expectations of dollar rate.