The table shows interest rates in three countries. There are no restrictions on buying bonds issued by foreign governments.
| Country | Interest rate on equally safe government bonds |
|---|---|
| A | 5 per cent |
| B | 8 per cent |
| C | 6 per cent |
Other things remaining the same, the currency of which country is likely to appreciate against the currencies of the other two?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Country B
Large funds move around the world in search of the highest interest rates. Country B pays the most, 8 per cent, so investors from A and C buy B’s currency to buy its bonds. Demand for B’s currency rises, and it appreciates.
NCERT (2026-27): “Interest Rates and the Exchange Rate … There are huge funds owned by banks, multinational corporations and wealthy individuals which move around the world in search of the highest interest rates. If we assume that government bonds in country A pay 8 per cent rate of interest whereas equally safe bonds in county B yield 10 per cent, the interest rate differential is 2 per cent. Investors from country A will be attracted by the high interest rates in country B and will buy the currency of country B selling their own currency. At the same time investors in country B will also find investing in their own country more attractive and will therefore demand less of country A’s currency. This means that the demand curve for country A’s currency will shift to the left and the supply curve will shift to the right causing a depreciation of country A’s currency and an appreciation of country B’s currency. …” |