In the above three statements 1,2 & 3. It is given that statement 1 is true.Need help in understanding why statement 1 is true and why statement 2 is false?
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So, in this question the 2nd statement explanation is straight foreward, that if a currency peg is likely to break and the currency is likely to weaken when allowed to float, its risk premium increases and so bond yields rise.
Now, in the first statement think from the perspective of a good developed market country which is about to show good economic growth. On this backdrop if you think deeply, currently the currency is severely undervalued but it is expected to rise ahead. If the market feels it is entering good recovery or expansion period then when currency rises ..bond yield also rise in tandem showing expansion phase of the economy.
But in the answer they have mentioned that “Chilean bond yields may be lower than they should be relative to British bonds.”
However, you are saying that if chilean currency is going to appreciate then its bond yields should also rise in tandem. Can you please explain ?