Reading 17: The Exchange Rate and the Balance of Payments-LOS following, exchange, investment, 2011, class

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Session 4: Economics for Valuation
Reading 17: The Exchange Rate and the Balance of Payments

LOS b: Explain the factors that influence supply and demand in the foreign exchange market.

 

 

Pauline Zeiss, CFA, is preparing a report on the investment climate in the country of Andalmosa. She has assembled the following data:

• The Andalmosan central bank’s actions have an indirect effect on exchange rates.
• Andalmosan currency is likely to depreciate.
• Andalmosan interest rates are low.

Given the information presented above, what conclusions can Zeiss draw about the Andalmosan government’s policies regarding currency supplies and exchange rates?

Currency supply

Exchange rate policy

A) Too high Flexible

B) Too low Crawling peg

C) Too high Crawling peg

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When a country adopts a flexible exchange-rate policy, the central bank doesn’t manipulate exchange rates, although its actions can affect exchange rates indirectly. Given the expectations that the currency will depreciate, this suggests that the currency supply must be too high. Low in country interest rates are likely to increase the supply of the currency on foreign exchange markets as investors seek higher returns elsewhere.

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Which of the following would increase the demand for U.S. dollars in the foreign exchange market?

A) The purchase of Japanese electronics by American consumers.

B) The purchase of a Chinese company by a U.S. investor.

C) The sale of U.S. computers to Belgian consumers.

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The sale of U.S. computers to Belgian consumers would require Belgian entities to buy the computers from U.S. manufacturers thereby converting their euros to dollars. Thus, there would be a supply of euros and a demand for U.S. dollars in the foreign exchange market. Both remaining choices would each cause a supply of dollars and a demand for the foreign currency in the foreign exchange marketplace.

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Analyst Bradley Lindge has collected information about the economy of the Grakh Republic. He has assessed the demand for exports from the country, the interest rates in the country, and estimates regarding future exchange rates. Lindge is most likely attempting to determine the:

A) supply of Grakh Republic currency.

B) demand for Grakh Republic currency.

C) expected change in Grakh Republic interest rates relative to those of foreign countries.

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The basic determinants of demand for any currency are the demand for exports from the country, interest rates for assets denominated in the currency, and expected future exchange rates.