Interest rates on a particular currency might be constrained by capital controls. Controls on international capital flows could include quotas on foreign lending and deposits or taxes on international capital flows. For instance, if Switzerland limits inflows of foreign money, then we could have a situation where the domestic Swiss deposit interest rate exceeds the external rate on Swiss franc deposits in other nations. Although foreigners would prefer to have their Swiss franc deposits in Swiss banks in order to earn the higher interest, the legal restrictions on capital flows might prohibit such a response.
It is also possible that a perceived threat to private property rights could lead to seemingly perverse interest rate relations. If the United States threatens to confiscate foreign deposits, the funds would tend to leave the United States and shift to the external dollar market. This could result in the Eurodollar deposit rate falling below the U.S. deposit rate.
In general, risk contributes to the domestic spread exceeding the external spread. In domestic markets government agencies help ensure the sound performance of domestic financial institutions, whereas the Eurocurrency markets are largely unregulated, with no central bank ready to come to the rescue. There is an additional risk in international transac- tions in that investment funds are subject to control by the country of currency denomination (when it is time for repayment) as well as the country of the deposit bank. For instance, suppose a U.S. firm has a U.S. dollar bank deposit in Hong Kong
Interest rates on a particular currency might be constrained by capital controls. Controls on international capital flows could include quotas on foreign lending and deposits or taxes on international capital flows. For instance, if Switzerland limits inflows of foreign money, then we could have a situation where the domestic Swiss deposit interest rate exceeds the external rate on Swiss franc deposits in other nations. Although foreigners would prefer to have their Swiss franc deposits in Swiss banks in order to earn the higher interest, the legal restrictions on capital flows might prohibit such a response.It is also possible that a perceived threat to private property rights could lead to seemingly perverse interest rate relations. If the United States threatens to confiscate foreign deposits, the funds would tend to leave the United States and shift to the external dollar market. This could result in the Eurodollar deposit rate falling below the U.S. deposit rate.In general, risk contributes to the domestic spread exceeding the external spread. In domestic markets government agencies help ensure the sound performance of domestic financial institutions, whereas the Eurocurrency markets are largely unregulated, with no central bank ready to come to the rescue. There is an additional risk in international transac- tions in that investment funds are subject to control by the country of currency denomination (when it is time for repayment) as well as the country of the deposit bank. For instance, suppose a U.S. firm has a U.S. dollar bank deposit in Hong Kong
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