Question

10. If a country has high inflation, what do you expect to happen to the value of that country's currency? Explain with reference to the current and capital account and with reference to supply/demand. You don't need to draw a diagram, but make certain that you explain why there are any changes in supply or demand. 11. When would you expect arbitrage to occur in a market and when won't it occur? Explain using two examples. 12. What does the following graph tell us about the US dollar? FRED 13. If a country has an economic recession, based on the current account use a supply/demand diagram to show what will happen to its currency. Explain any shifts in your diagram. 14. Given the following data what does this tell you about the bond market (both the bond market as a whole and individual corporations listed here) Corporation Coupon rate Price Maturity date Rating BBB 6% 105 2030 AA CCC 6% 100 2030 BB DDD 7% 107 2030 AA

Answer 1

Answer:

The value of domestic currency will decrease if the country is experiencing high inflation. This is because, to purchase the same amount of goods and services, one needs more currency. Hence the value declines.

The increased price due to inflation causes high price in international market resulting in decrease in export. Also, since the value of domestic currency has decreased, the country has to pay more money for imports. The result is current account deficit.

Inflation also reduces the real interest rate which makes it unattractive for foreign investors to invest. High inflation also results in volatility in market. Hence capital inflow decreases. Thus capital account is also in deficit.

Inflation arises if there is excessive demand on part of consumers because they may have higher money supply. Supply remaining the same, demand increases drastically. There may be artificially reduced supply in order to earn even at higher prices. This is called black marketing. Thus supply and demand both may be affected due to inflation.