In the interest rate parity condition with imperfect substitutes ...

[Tazate]

In the interest rate parity condition with imperfect substitutes and a risk premium of
 
  A) an increased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.
  B) a decreased stock of domestic government debt will raise the difference between the expected returns on domestic and foreign currency bonds.
  C) an increased stock of domestic government debt will reduce the difference between the expected returns on domestic and foreign currency bonds.
  D) an increased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.
  E) a decreased stock of domestic government debt will have no effect on the difference between the expected returns on domestic and foreign currency bonds.

Question 2

What are the predictions of the PPP theory with regards to the real exchange rates?
 
  What will be an ideal response?

[robbielu01]

Answer to Question 1

A

Answer to Question 2

The real exchange rate between two countries is a broad summary measure of the prices one country's goods and services relative to the other's. PPP predicts that the real exchange rate never permanently changes, which is different from nominal exchange rates that deals with the relative price of two currencies.