INTERNATIONAL PARITY RELATIONSHIP 131
value of the two currencies. Suppose the risk-free interest rate is 4.5 percent in the United
States and 8 percent in India. Would this lead to a diversion of investment funds from the
United States to India? Not necessarily. Investors have to consider interest rates, as well as the
expected change in the foreign exchange rate over the period during which the investment
is held. The return on the investment in India by a US investor is the explicitly stated interest
rate/dividend rate as converted into US dollars.
Suppose an investor has a certain amount of funds to invest. He considers several
investment opportunities and decides to put some funds initially in a bank deposit for six
months. So, each ...