Foreign Exchange Market: Graph
Channel: Department of Economics
Date: 07/02/2012

This clip develops a diagram for the foreign exchange market based on a simple no-arbitrage condition. The two axes show current exchange rate versus home currency returns of the two financial investments. The home currency return to home currency asset is independent of the exchange rate, whereas the home currency return to foreign currency investment rises with a more appreciated (lower) exchange rate, because the expected exchange rate is assumed fixed. The argument is based on the standard textbook by Krugman/Obstfeld.