CFA Level I · CFA Level I Exam · Capital Flows and the FX Market
Large, sustained capital inflows into an emerging market that has a flexible exchange rate are most likely to cause the domestic currency to:
The currency will most likely appreciate, and asset prices may be inflated. Foreign investors need to buy domestic currency to invest, which raises its demand under a flexible exchange rate, while the extra liquidity can lift equity and property prices.
- Adepreciate and reduce asset prices
- Bappreciate and potentially inflate asset pricesCorrect
- Cremain unchanged because flows are offset by reserves
Explanation
Foreign investors must buy domestic currency to purchase domestic assets, raising demand for it and causing appreciation. Inflows can also push up equity and real estate prices and lower domestic interest rates, raising risk of bubbles and sudden reversals.
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