Question 3:

An increase in foreign exchange risk

1. will lead to an increase in both nominal and real interest rates in the domestic economy.

2. will lead to an increase in domestic real interest rates but not nominal rates.

3. will lead to an increase in the rate of depreciation of the domestic real exchange rate.

4. will lead to a decline in both nominal and real domestic interest rates as long as foreign interest rates are constant.

Choose the correct option.