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IAI Actuarial Core Principles · Business Economics · Globalisation and multinational business

A country with a floating exchange rate sees a large rise in foreign portfolio investment into its equity market. Everything else is unchanged. Which outcome is most likely, and what is its likely effect on its exporters?

The currency is likely to appreciate, making exports less price-competitive abroad. Foreign investors need to buy the domestic currency to purchase its equities, raising demand for it, and a stronger currency raises the foreign-currency price of exports.

  1. ACurrency appreciates, making exports less price-competitive abroadCorrect
  2. BCurrency depreciates, making exports more price-competitive abroad
  3. CCurrency appreciates, making exports more price-competitive abroad
  4. DCurrency is unchanged because equity flows are not in the balance of payments
  5. Currency depreciates, making imports cheaper for the rest of the world

Explanation

Foreign investors must buy the domestic currency to purchase equities, raising demand and causing appreciation. A stronger currency raises the foreign-currency price of exports, reducing competitiveness. Equity flows are recorded in the financial account, so they do affect currency demand.

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