I have a really basic doubt:
If the interest rate is higher in the US than in the UK, then
A) The dollar is expected to appreciate with respect to the pound.
B) The pound is expected to appreciate with respect to the dollar.
C) The interest rate in the US is expected to increase.
D) The interest rate in the US is expected to decrease.
The correct answer is given as B because of the uncovered interest rate parity condition. I understand how it works, but if you look at it from another perspective, shouldn't it be the case that more investments are flowing into the economy, causing the dollar to appreciate?
Both answers seem equally logical to me and I am really confused.
What your saying is true, but you are ignoring the capital account. Think of what would happen to the NX due to this appreciation, US exports will decline and imports will increase... The opposite with UK, its exports would increase and imports decline.... This would balance off at the parity condition.. i(us) = i(uk)+ expected appreciation of pound...