Ignoring risk differences, if we observe American investors purchasing foreign bonds when the U.S. interest rate is above the foreign interest rate, we could assume that:
A) American investors lack good information.
B) these investors expect the dollar to appreciate over the life of their investment.
C) these investors expect the dollar to depreciate over the life of their investment.
D) these investors expect that U.S. inflation will slow.

Question

Quizplus · Accepted Answer

If American investors purchase foreign bonds when the US interest rate is higher, it suggests that they believe their investment will yield a higher return due to currency appreciation. As a result, they must anticipate the dollar declining in value relative to the foreign currency over the life of their investment. Choice A is incorrect because it implies that investors are making a mistake when, in reality, they might have specific information or investment views. Choice B is incorrect because it indicates that investors are expecting the opposite outcome of what is suggested in the question. Choice D is incorrect because low US inflation, as opposed to high inflation, is associated with lower US interest rates, which would make foreign bonds less attractive.

Ignoring Risk Differences, If We Observe American Investors Purchasing Foreign