Question

An exchange rate of euro in terms of the U.S. dollar that is greater than the equilibrium one brings about the following effects:

	Traders will start selling bonds denominated in euros and buying bonds denominated in dollars.
	Traders will start selling bonds denominated in dollars and buying bonds denominated in euros.
	The euro depreciates and the dollar appreciates.
	(a) and (c).
	None of the above.

Answer 1

Since the exchange rate is the ratio of two countries currency values.

The equilibrium exchange rate is the rate at which demand and supply of same currency are equal.

Since the exchange rate of euro in terms of dollar is greater than the equilibrium exchange rate, it means the demand for dollar increases at existing exchange rate. Hence dollar appreciatand euro depreciates.

So it is profitable to purchase dollar denominated bonds, so trader buys dollar denominated bonds and sells euro denominated bonds.

Hence option( a) and ( c ) are correct answer.