Suppose the one-year nominal interest rate is 2.0 in the United ...

[scienceeasy]

Suppose the one-year nominal interest rate is 2.0 in the United States and 5.0 in Canada. Should you hold Canadian bonds or U.S. bonds? Explain.
 
  What will be an ideal response?

Question 2

For this question, assume that the Phillips curve equation is represented by the following: t - t-1 = (m + z) - ut. Which of the following will not cause an increase in the natural rate of unemployment?
 
  A) a reduction in m
  B) a reduction in z
  C) an increase in
  D) an increase in the expected rate of inflation
  E) all of the above

[uniquea123]

Answer to Question 1

It depends whether you expect the Canadian dollars to depreciate relative to the dollar over the coming year by more or less than the difference between the U.S. interest rate and the Canada interest rate, or 3.0 in this case (5.0 - 2.0). If you expect the Canadian dollars to depreciate by more than 3.0, then, despite the fact that the interest rate is higher in Canada than in the United States, investing in Canadian bonds is less attractive than investing in U.S. bonds. By holding Canadian bonds, you will get higher interest payments next year, but the Canadian dollars will be worth less in terms of dollars next year, making investing in Canada bonds less attractive than investing in U.S. bonds. If you expect the Canadian dollars to depreciate by less than 3.0 or even to appreciate, then the reverse holds, and Canadian bonds are more attractive than U.S. bonds.

Answer to Question 2

D