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Int Rates are Different in each countries

So Investors move from countries having lower interest rate to countries having higher interest rates

This leads to appreciation of currency of country having higher interest rates

 

Example

Suppose there are 2 Countries A and B

Both countries issue Govt Bonds

Interest Rate on Govt Bonds is 8% in A and 10% in B

Hence, there is Interest Rate Differential of 2%

B Country's Investors will prefer to invest in their own country rather than in Country A

Also Investors in Country A will prefer to invest in Country B

So they will purchase foreign currency of B Country

Hence, there will be more demand for B's currency and hence B Country currency will appreciate

Assumption

There is no restriction of buying bonds of foreign governments

Effect of Interest on Exchange Rates - Teachoo.JPG

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Transcript

Effect of Interest on Exchange Rates Suppose there are 2 Countries A and B Country A issued Govt Bonds @ 8% Investors of Country A buy this bonds. Suppose Country B also issues Govt bonds but gives 10% interest What will Investors do? Country A Govt Bonds 8% Country B Govt Bonds 10% It has lower Rate of Interest Investors will sell Country A bonds It has higher Rate of Interest Investors will buy Country B bonds Demand of A Currency Decreases (Depreciation) Demand of B Currency Increases (Appreciation)

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CA Maninder Singh is a Chartered Accountant for the past 12 years. He also provides Accounts Tax GST Training in Delhi, Kerala and online.