Just as with the price of a good, the price, or exchange rate, of a currency is determined by supply and demand. However, rather than using a traditional supply and demand analysis as shown in Marthinsen, currency traders often consider whether foreign funds will flow into or out of a country as a result of a particular economic circumstance. If foreigners wish to make domestic purchases or investments, foreign currency must first be exchanged for the domestic currency. Thus, foreign funds flowing into a country increase the demand for the domestic currency and it appreciates. Funds flowing out reverse this process leading to depreciation of the domestic currency. In the table, place an X to indicate whether each economic condition will cause foreign funds to flow in or out of the country and whether the domestic currency will appreciate or depreciate.

Domestic circumstance


flow in


flow out





Real interest rates are higher than in other countries


Risk of civil war


Business taxes are raised above world average


Expected stock market returns are better than elsewhere


Inflation increases


A large deposit of rare earth minerals is discovered


Rapidly growing manufacturing sector imports more foreign raw materials


World commodity prices (such as oil or grain) fall in a country that is a major commodity exporter


GDP increases


PI falls


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Kristelle Balando
Kristelle BalandoLv10
29 Sep 2019

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