Consider the Euro-dollar exchange rate (nominal exchange rate = Euros/$US). For each of these examples, use a supply/demand diagram for the foreign exchange market to show the impact on the exchange rate. In each case, does the exchange rate appreciate or depreciate?
a. A debt crisis in Europe causes investors holding Euro denominated securities to move to dollar denominated securities.
b. The European Central Banks raises interest rates, attracting inflows from U.S. financial investors into European markets.
c. The European Central Bank intervenes in the market by buying dollars
Moving to the dollar denominated securities, will increase the demand of dollars. It will depreciate, the Euro / USD exchange rate. It means that 1 USD can buy more euros now.
Increase in interest rate by the European Central Bank, will increase the supply of dollars as US FIIs are moving to the European market. It will appreciate the Euro / USD exchange rate.
It will increase the demand for USD and It will depreciate, the Euro / USD exchange rate. It means that 1 USD can buy more euros now.
Get Answers For Free
Most questions answered within 1 hours.