The term structure relationships regarding different interest rates approximately reflect expected exchange rate changes.

Question

Quizplus · Accepted Answer

The term structure refers to the relationship between interest rates of debt securities with different maturities. According to the unbiased forward rate hypothesis, the forward exchange rate should equal the expected future spot exchange rate. Therefore, the term structure of interest rates can provide information on market participants' expectations of future exchange rate movements. For example, if yields on longer-term bonds are higher than yields on shorter-term bonds, this could suggest that investors expect the currency to appreciate in the future, increasing demand for longer-term bonds and pushing their yields down. Conversely, if yields on shorter-term bonds are higher than yields on longer-term bonds, this could suggest that investors expect the currency to depreciate, leading to higher demand for shorter-term bonds and pushing their yields up.

The Term Structure Relationships Regarding Different Interest Rates Approximately Reflect