With reference to "Speculation" in the foreign exchange market, consider the following statements: 1. If investors expect a foreign currency to appreciate, they will demand more of it in the present. 2. Expectations of currency appreciation have no impact on the actual exchange rate. 3. Speculation can destabilize the exchange rate by amplifying market forces. Which of the statements given above is/are correct?

The correct option is 1 and 3 only. Explanation Speculation in the foreign exchange market involves trading currencies with the primary objective of making a profit from expected future fluctuations in exchange rates. It relies heavily on market expectations regarding the future value of a currency. Statement-wise Analysis: - Statement 1 is Correct: If market participants expect a foreign currency to appreciate (increase in value) in the future, they will attempt to purchase it in the present to sell it later at a higher price. This profit motive drives an increase in the current demand for that currency. - Statement 2 is Incorrect: Expectations of appreciation directly impact the actual exchange rate. As investors demand more of the currency in the present (anticipating future gains), the demand curve for that currency shifts to the right. Consequently, the exchange rate rises immediately, causing the currency to appreciate in the present. This phenomenon is often referred to as a self-fulfilling prophecy. - Statement 3 is Correct: Speculation can amplify market trends and lead to volatility. If a large number of speculators bet against a currency, it can lead to a sharp depreciation or appreciation that may not align with the country's economic fundamentals, thereby destabilizing the exchange rate mechanism. Key Takeaway: In a floating exchange rate system, current exchange rates are significantly influenced by expectations of future values. An expectation of appreciation increases current demand, leading to immediate actual appreciation.

With reference to "Speculation" in the… - NCERT Class 12 Economics MCQ

NCERT Class 12 Economics — Chapter 8: Open Economy Macroeconomics

mcqmedium

With reference to "Speculation" in the foreign exchange market, consider the following statements:

If investors expect a foreign currency to appreciate, they will demand more of it in the present.
Expectations of currency appreciation have no impact on the actual exchange rate.
Speculation can destabilize the exchange rate by amplifying market forces.

Which of the statements given above is/are correct?

NCERT textbook question

From NCERT Introductory Macroeconomics · Page 9

Options

A1 and 2 only
B1 and 3 only
C1, 2 and 3
D2 only

Did you get this right?

Solution

The correct option is 1 and 3 only.

Explanation

Speculation in the foreign exchange market involves trading currencies with the primary objective of making a profit from expected future fluctuations in exchange rates. It relies heavily on market expectations regarding the future value of a currency.

Statement-wise Analysis:

Statement 1 is Correct: If market participants expect a foreign currency to appreciate (increase in value) in the future, they will attempt to purchase it in the present to sell it later at a higher price. This profit motive drives an increase in the current demand for that currency.
Statement 2 is Incorrect: Expectations of appreciation directly impact the actual exchange rate. As investors demand more of the currency in the present (anticipating future gains), the demand curve for that currency shifts to the right. Consequently, the exchange rate rises immediately, causing the currency to appreciate in the present. This phenomenon is often referred to as a self-fulfilling prophecy.
Statement 3 is Correct: Speculation can amplify market trends and lead to volatility. If a large number of speculators bet against a currency, it can lead to a sharp depreciation or appreciation that may not align with the country's economic fundamentals, thereby destabilizing the exchange rate mechanism.

Key Takeaway:
In a floating exchange rate system, current exchange rates are significantly influenced by expectations of future values. An expectation of appreciation increases current demand, leading to immediate actual appreciation.

Your note

More from Chapter 8: Open Economy Macroeconomics

With reference to 'Transfer Payments' in the Balance of Payments, consider the following statements: 1. They require the recipient to provide goods or services in return. 2. They are receipts which the residents of a country get for free. 3. They consist exclusively of payments made for the import of capital goods. Which of the statements given above is/are correct?

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In a fixed exchange rate system, if there is an excess supply of foreign currency, the Central Bank must:

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Consider the effect of income on the exchange rate. If domestic income increases: 1. Consumer spending on imported goods decreases significantly. 2. The demand curve for foreign exchange shifts to the right. 3. The domestic currency is likely to depreciate. Which of the statements given above is/are correct?

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Which of the following items are included in the 'Current Account' of the Balance of Payments? 1. Export of goods 2. Import of services 3. Remittances and grants 4. External Commercial Borrowings

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Consider the following statements regarding the Balance of Trade (BOT): 1. It is the difference between the value of exports and imports of goods only. 2. Export of goods is entered as a debit item in BOT. 3. A Trade Deficit arises if a country imports more goods than it exports. Which of the statements given above is/are correct?

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