What is the significance of interest rates in currency value?

The significance of interest rates in determining currency value primarily revolves around their influence on foreign capital flows. Higher interest rates are attractive to international investors looking for good returns on their investments, such as bonds and savings accounts. When a country offers higher interest rates compared to other countries, it draws foreign capital, which increases demand for that currency. This heightened demand typically leads to an appreciation of the currency's value.

For instance, if investors anticipate higher returns from investments in a country due to its elevated interest rates, they will convert their own currency into the local currency to invest. This influx of investment capital signals strong economic conditions, thereby supporting the currency's strength.

In contrast, the other options do not accurately represent the relationship between interest rates and currency valuation. The idea that interest rates have no impact on currency value overlooks the fundamental principles of forex markets. The assertion that interest rates only affect domestic currency fails to recognize that currency value is influenced by comparison with other currencies in the global market. Finally, while lower interest rates may initially stimulate the economy, they typically do not increase currency value and can lead to depreciation as they may signal weaker economic conditions.