6. In open economies and with freely mobile finan- cial capital, savers have the opportunity to pur- chase financial assets from foreign as well as domestic borrowers. When judging whether to purchase domestic or foreign financial assets, savers must compare more than interest rates. This is so because to buy foreign assets requires that they purchase foreign currency, and when the asset matures, they must then sell that currency. If the value of the currency changes during the time the foreign asset is held, the rate of return on that investment is affected. The decision of whether to purchase a foreign asset thus requires that savers form an expectation about, future movements in the exchange rate. Interest rate parity is a condition that states that the gross expected return on a bond issued by a foreign borrower will be the same as the gross expected return on a bond issued by a domestic borrower. If this condition does not hold, arbitragers will buy and sell domestic and foreign assets until interest rates adjust to make it so. In this chapter, we assume real interest rate parity is satisfied and that savers do not expect the exchange rate to change. These two assumptions mean that the domestic interest rate rwill always adjust until it is equal to the foreign interest rate 7.