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

Under a floating exchange rate system, a sustained rise in Indian interest rates relative to US rates, with other factors unchanged, would be expected to cause which of the following?

Higher Indian interest rates relative to US rates attract foreign capital, raising demand for rupees and causing the rupee to appreciate under a floating system. The inflow of funds seeking higher returns drives this, all else being equal.

  1. ACapital outflows and rupee depreciation
  2. BCapital inflows and rupee appreciationCorrect
  3. CCapital inflows and rupee depreciation
  4. DNo change in capital flows because exchange rates are floating
  5. Capital outflows and rupee appreciation

Explanation

Higher relative Indian interest rates make rupee assets more attractive to foreign investors. Demand for rupees rises, so the rupee appreciates. The other options pair the capital flow and currency movement inconsistently or ignore the flow.

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