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IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates

In a freely floating exchange rate system, the rupee will tend to appreciate against the US dollar if which of the following occurs, other things being equal?

The rupee appreciates when foreign investors buy more Indian equities, because they must buy rupees to do so. This raises demand for the rupee in the foreign exchange market. The other developments increase the supply of rupees or the demand for dollars, which would weaken the rupee.

  1. AForeign investors increase their demand for Indian equities, raising demand for rupeesCorrect
  2. BIndian residents increase their imports of crude oil, raising demand for dollars
  3. CThe Reserve Bank of India cuts its policy rate sharply, making rupee deposits less attractive
  4. DIndian inflation rises well above US inflation
  5. Indian firms increase their overseas investment, raising the supply of rupees

Explanation

Greater foreign demand for Indian equities requires purchasing rupees, shifting the demand curve for rupees to the right and raising its price. The other options either increase demand for dollars or raise the supply of rupees, or reduce rupee attractiveness, all of which push the rupee down.

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