Tighter Monetary Policy = Appreciation or Depreciation?

A

ajb1

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From Reading 18, Example 3:
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If interest rates go up in India, the impact on the currency rate would be depreciation, no? Say INR / USD rate is 60/$ today, and India rates are 15% and 0% in the US, the forward rate on the pair would be 69/$ (i.e. it is appreciating from 60/$). What am I missing?
And the answer is B by the way.
 
Welp, for the short term biased towards appreciation.
But that’s in real life, all else equal. Not sure what the context here is.
 
I just read the explanation and the wording is horrible.
“This increase will cause the INR to appreciate against the USD, but because the USD is the base currency this will be represented as depreciation in the INR/USD rate.”
Horrible question, horrible explanation. They’re saying the actual rate (as in the actual number) for INR/USD will drop in the short term so the number will depreciate but the currency will appreciate in the short term since USD is the base currency.
 
verse214 wrote:
I just read the explanation and the wording is horrible.
“This increase will cause the INR to appreciate against the USD, but because the USD is the base currency this will be represented as depreciation in the INR/USD rate.”
Horrible question, horrible explanation. They’re saying the actual rate (as in the actual number) for INR/USD will drop in the short term so the number will depreciate but the currency will appreciate in the short term since USD is the base currency.
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It’s a tricky question.
Although the CFAI curriculum seems to have a variety of ambiguities in many areas, I think the take-away here is to be conscious of the currency being referenced. The base currency (USD in this case) is always the currency that is referenced.
So they’re not asking you whether the INR will appreciate, rather will the USD priced in INR terms go up or down. Monetary tightening in the price currency causes relative depreciation of the USD in the INR/USD pair.
 
If you go back and read the question it’s horrendous. It’s not even tricky
They talk about the INR the entire time and then they throw in the question with the “INR/USD”. It’s framed to make you think they want you to state what you think INR will do relative to the dollars not what the actual number in the INR/USD rate will do. No one refers to “depreciation” as the number in the rate.
 
this is an example of a question that is ambigous enough that would get an adjustment in the final grading of the the exam (everyone gets the points for A or B)..
 
WTF, they are asking about the impact on the dollar?
 
ajb1 wrote:
WTF, they are asking about the impact on the dollar?
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Specifically, the dollar relative to the Indian Rupee as a trade pair.
The question is really confusing because of the statement about how ”She reconsiders her short-term view for the Indian rupee”
 
It isn’t that difficult. Got the answer right the first time itself. Just think of this from the capital flows perspective, from the angle of hot money since it’s short term. Higher rates, greater the incentive to earn higher rates causing capital flows to come to INR pulling INR up against the USD, coz institutions sell the dollar to buy Rupees.
 
^ agree with you. The answers is straightforward, but the question is very tricky and well-designed to trip you up if you’re in a panicky state during the exam.
 
AmruthSundarkumar wrote:It isn’t that difficult. Got the answer right the first time itself. Just think of this from the capital flows perspective, from the angle of hot money since it’s short term. Higher rates, greater the incentive to earn higher rates causing capital flows to come to INR pulling INR up against the USD, coz institutions sell the dollar to buy Rupees.
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um yess but the answer is B “biased towards depreciation”. and the question isnt clear whether they are referring to the depreciation of the price or the depreciation of the inr v usd. they are actually referring to the price which is pretty ridiculous bc no one uses that in the industry.
 
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