Interest Rates an Exchange Rate Essay Example | Topics and Well Written Essays - 1250 words

Interest place an Exchange Rate - Essay ExampleThe disposal raised vex pass judgment to increase the solicit for pound in the international market, this increase in demand was anticipated to make the pound stronger against an separate(prenominal) major currencies, however a speculative attack by trustors led to the loss of strains, the government disordered and some investors gained huge profits on that day.This ideal depict that there is a alliance betwixt the accustomed interest rates and the exchange rate, using historical data a arena ass use the data to estimate an appropriate model that will help in forecasting prospective values. The model depicts that a overdress in interest rate will lead to a prove in the value of the currency, when interest rates fall accordingly the value of the currency pooh-poohs, the following plat shows the relationship between the both variablesFrom the above diagram it is evident that an increase in the interest rates will lead to an increase in the value of the currency, however a decline in interest rates will lead to a decline in the value of the currency. However the assumption of this model is that there are no speculative attacks and that the exchange rate depends on the demand and supply of the currency.The relationship between the exchange rate and the interest rates can be demonstrated using two currencies from countries with different interest rates, we take hypothetical values and countries to demonstrate this and we choose realm A and country B, for country a the interest rate is 4% and for country B the interest rate is 6%, those who have their funds deposited in country A will earn 4% for their investment, however it is more than profitable to invest the funds or deposit the amount in country B collectible to high interest rates and therefore higher earning.For this reason therefore investors will move their fund from country A to country B, investors from country A will exchange their mon ey to get country B currencies, as a final result of this the demand for country B currency will rise and therefore will the value of the currency. Therefore higher interest rates will encourage investors to invest in country B, if country B was to increase the interest rates from 5% to 10% then the higher will be the demand for their currency.British forecastThe exchange of the pound in 1992 was laid by the market demand and supply, in September the British government experienced a decline in the demand for their currency, many investors started selling the pound to acquire other currencies, as a result of this demand declined and therefore the pound lost value against other currencies.The government had a role to accept to resolve the crisis and this was done by increasing interests rates as described by the above model, the prevailing interest rates at the time was 10% and the government increased the interest rates to 12%, however despite this effort the investors still sold the pound to hold other currencies.Realizing this problem the government on the same day announced an increase in interest rates to 15%, this was the heartbeat attempt to resolve the problem, however it was unfortunate that investors kept on selling the pound and purchasing other currencies, as a result of this the value of the pound declined and this resulted into a decline in the value of the