If the Deutsche Mark and the British Pound Exchange Rates

question 29

Multiple Choice

If the Deutsche Mark and the British pound exchange rates are fixed, and the German Bundesbank conducts a tight monetary policy to counteract an expansion in German GDP, interest rates in Germany will ____, which will force Britain to ______.

• A) fall; default
• B) rise; raise its rates to maintain interest parity and the fixed exchange rate
• C) fall; sell gold
• D) rise; lower its rates to maintain interest parity and the fixed exchange rate

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Definitions:

Risk-free Interest Rate

The theoretical rate of return of an investment with zero risk of financial loss, often represented by the yield on government bonds.

Two-factor Model

A financial model that considers two sources of risk in its valuation or pricing, typically used in evaluating or predicting financial returns.

Market Risk

The risk of losses due to factors that affect an entire market or asset class, also known as systematic risk, which cannot be eliminated through diversification.

Interest Rate Risk

The potential for investment losses resulting from changes in interest rates.