Question

Since​ 1982, Denmark has pegged the exchange rate for the Danish crown against the German mark first and later against the euro. In recent​ weeks, the fixed exchange rate regime has come under strain as the euro has fallen​ sharply, leading to speculation that​ Denmark's currency peg to the euro will break.

What is​ Denmark's exchange rate​ policy? Explain why expectations about a possible break in the link of the crown and euro might put the crown under strain.

With an expected break in the link of the crown and the euro​ _______.

A.

Denmark has a flexible exchange rate​ policy;

people will expect the crown to​ appreciate, so they will sell euros and buy crowns and the crown will appreciate immediately

B.

Denmark has a crawling peg exchange rate​ policy;

without the tie to the​ euro, inflation in Denmark will rise quickly

C.

Denmark has a fixed exchange rate​ policy;

people will expect the crown to​ depreciate, so they will buy euros and sell crowns and the crown will depreciate faster than the euro

D.

Denmark has a fixed exchange rate​ policy;

people will expect the crown to​ appreciate, so they will sell euros and buy crowns and the crown will appreciate immediately

Answer 1

Solution: Denmark has a fixed exchange rate ​policy; people will expect the crown to​ appreciate, so they will sell euros and buy crowns and the crown will appreciate immediately

Explanation: Since the country’s fixed exchange-rate regime will be under extreme strain, thus the speculators have a belief that the currency of Denmark (peg) to the euro will break, thus providing them an opportunity to outsize profits on the Danish assets they acquire when the crown value increases