Schweser Exam 2 PM understand, quantity, currency, increase, interest

spartanag07

That’s some killa currency questions, anyway understand where I went wrong on most of them but this one:
Williams First analyses the effects of rising nominal Bundovian interest rates relative to US interest rates on the supply and demand for BU (the currency of Bundovia). He determines that the increase in Bundovian nominal interest would increase the demand for BU and, because the BU supply curve is upwards sloping, the BU will appr and the equilibrium quantity of BU will increase proportionately.
Is williams correct:
Yes
No, cos the supply of BU will increase, and the BU will depr instead of appr
No cos the supply of BU will decrease and, as a result, the equilibrium quantity of BU will not change significantly.
Can someone please explain the answer: C

bigredhockey55

yes you’re right. but lets assume Fisher holds, meaning that an increase in nominal rates is all due to inflation. we know that an increase in real interest rates:
- increases demand for currency
- decreases supply of currency
- appreciates currency
- equilibrium quantity does not change
if there is an increase in nominal interest rates, and Fisher holds, how do the above factors change?

LorrinCFA

I was looking for real interest rates as well, as it makes the question a lot clearer. However this question would only be incorrect if we’re assuming the international fisher theory is holding (that all real interest rates are equal). Otherwise an increase in nominal rates may indicate an increasing real rate, as it doesn’t specify it would be all inflation (I think).
Regardless, it’s things like this that make me dislike Schweser. They are a bit to casual with their wording sometimes, so it makes you analyze things that the question isn’t necessarily meant to test.

profil

spurries: this through me off too. totally would be fine with the Q if it said real int rate. apparently schweser book one page 299 says that an increase in NOMINAL rates cauess a currency to appreciate as demand for it rises. i then went to schweser errata and low and behold, it says this is an error and the nominal should be changed to real.
so in short, this Q is incorrect. if it said real it would be fine.
if the Q is intended to say nominal, can anyone advise what the effects would be on all the factors above?

LorrinCFA

What confused me a bit on this one is that it says NOMINAL rates would increase. I agree with what you say above Job711, but the fact that its nominal and not real confused me. Any clarification

zbird2134

Makes sense, your explanation makes so much more sense to me than the answers. Thanks a lot for the help

IAmNeil

Supply and demand for currency are affected by the same factors but in opposite ways. The net affect of any change, is the price will increase or decrease, but the quantity supplied will stay the same. Visualize a Supply and Demand graph in the following graph.
For instance, if real rate increases, foreign demand for the currency shifts to the right. At the same time though, the amount people are willing to supply decrease because they want to invest in the higher domestic real rate. So the supply curve shifts to the left. The net affect, is the price of the currency increases, but the shift to the right in demand and the shift to the left in supply, offset each other and the equilibrium quantity remains unchanged.