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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

Funds

flow in

Funds

flow out

Currency

appreciates

Currency

depreciates

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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