in arbitrage pricing theory is the identification of priced factors, and that such factors most frequently are "the key macro economic variables for each country: money supply, interest rate, inflation rate, industrial production, real GNP, international reserves, and balance of trade."5
The Roles of Transactions Costs and Interest Rates in Relation to Arbitrage and the
The four types of market conditions that are expected to affect exchange rates most are (1) changes in the value of exports and imports, (2) differential rates of inflation, (3) changes in domestic interest rates; and (4) changes in foreign interest rates. If the value of a country's exports increases relative to the value of its imports, the value of the country's currency is (other things being equal) expected to increase in the foreign currency exchange markets. Alternatively, if the value of imports increases relative to the value of exports, the value of the currency is expected to decrease. Other factors remaining unchanged, if the inflation rate in country "A" is greater than that in country "B," the value of country "A's" currency is expected to decrease relative to country "B's" currency, and vice versa. An increase in real interest rates (nominal interest rates adjusted for inflation) in a country's economy is expected to attract foreign capital, which, in turn, will cause the value of the country's currency to increase in foreign currency exchange. Conversely, a decrease in real interest rates is expected to cause the value of a country's currency to decrease in international currency exchange markets. Changes in foreign interest rates affect the foreign currency value of a country's currency in a manner exactly the opposite of the effect caused by changes in domestic interest rates. Changes in foreign interest rates are expected to draw funds away from a country's economy, and, in turn, cause the foreign currency exchange value of the country's...