If the term structure of interest rates in two countries differ,the differences reflect
A)expected price levels over time.
B)expected GDP differences.
C)the absence of covered interest arbitrage.
D)expected exchange rate changes over time.

Question

Quizplus · Accepted Answer

The term structure of interest rates refers to the relationship between the yields, or interest rates, on bonds of different maturities within a country. When the term structure of interest rates in two countries differ, it reflects expected exchange rate changes over time. This is because interest rates affect capital flows and therefore impact the demand for a currency, which in turn affects its value relative to other currencies. Differences in interest rates between two countries may lead investors to buy bonds in one country and sell bonds in another, which can impact exchange rates. Therefore, the term structure of interest rates can affect exchange rates, which impact the relative value of two currencies.

If the Term Structure of Interest Rates in Two Countries