Yield differentials and their affect on currency values.

Yield differentials is the difference between interest rates in various countries and how it affects currency values. As an example, let's use German and American securities to illustrate how interest rates affect exchange rates.

All else being equal it stands to reason that a higher yield on German securities (compared to American securities) would make German securities more attractive. What's more, an increase in German yields would raise the flow of U.S. dollars into German securities, and decrease the outflow of Deutsche marks to American securities. This increased flow of funds into Germany would lower the value of the U.S. dollar and increase the value of the Deutsche mark. Hence, the Deutsche mark to U.S. dollar ratio, as it is represented in the foreign exchange market, would potentially decrease.