Terest rate parity recognizes that when you invest in a country other than your home country, two factors affect your investment—returns on the investment itself and changes in the exchange rate. Which of the following would cause the overall return on your investment to be higher than the investment’s stated return? The currency in which the investment is denominated appreciates relative to your home currency. The currency in which the investment is denominated depreciates relative to your home currency. Your home currency appreciates relative to the currency in which the investment is denominated.

The currency in which the investment is denominated appreciates relative to your home currency.

Explanation:

If the currency that your investment was denominated in, increases in value against your own domestic currency, you will receive a return on your investment to be higher than the investment’s stated return.

Why?

Because you will have to covert the other currency to your own currency to use it. And when you do, it will give you more of your domestic currency because it appreciated against it.

For example, you invested in some Italian pizza company in Sicily and you were supposed to get a 5% return on €100.

When you made this investment the dollar was at 1.5 to the Euro meaning that when your €5 came in you would receive $7.5.

But the Euro gained on the dollar so now the Dollar is 1.75 to the Euro.

You get your €5 but this time when you convert it goes to $8.75.

That's the logic.

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