Capital flows freely between two countries and the countries have fixed exchange rates. The treasury bonds of each country have similar maturities but different expected returns. What can you deduce from this information?
What will be an ideal response?
The risk must be different. The ability of capital to flow freely would have investors pursuing the higher expected return and if the risk were the same these two securities should have the same expected return. Given the expected returns aren't the same we can deduce the risk is not the same.
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A) vertical. B) horizontal. C) downward sloping. D) upward sloping.