Assuming sticky prices and given expectations of future exchange rates, what is the short-run effect on the exchange rate of the U.S. dollar (purchasing euros) and on domestic and foreign rates of return if there is a temporary increase in the quantity of U.S. dollars?

Question

a. Rates of return on domestic and foreign assets diverge, as the dollar appreciates.
b. Domestic and foreign rates of return both fall, as the dollar depreciates.
c. Domestic and foreign rates of return converge, as the dollar depreciation lowers returns for U.S. investors who purchase euro-based assets.
d. Rates of return on euro assets fall, causing investors to switch into U.S. assets and, therefore, the U.S. dollar appreciates against the euro.

Answer 1

Answer: c. Domestic and foreign rates of return converge, as the dollar depreciation lowers returns for U.S. investors who purchase euro-based assets.