Question

Part I.

If a central bank is selling its own currency in the foreign exchange market

  

a. It must have a fixed exchange rate

   

b. It has a BOP surplus

   

c. It has a BOP deficit

   

d. It has a CA deficit

   

e. It has a CA surplus

Part II.

If a central bank sells foreign currency (buys its own currency) in the foreign exchange market and simultaneously sells government bonds in the domestic market (an open market operation) then:

  

a. The money supply will expand and the currency will fall in value.

   

b. The foreign exchange intervention has been effectively sterilized.

   

c. The money supply will contract and the currency will rise in value.

   

d. The money supply will expand and the currency will rise in value.

   

e. The money supply will contract and the currency will fall in value.

Part III.

If a central bank simultaneously sells its own currency in the foreign exchange market AND purchases bonds in domestic open market operations then

  

a. The currency will depreciate as both of these actions cause the money supply to increase

   

b. The currency will appreciate as both of these actions cause the money supply to increase

   

c. The currency will appreciate as both of these actions cause the money supply to decrease

   

d. The second action sterilizes the first action

Answer 1

Part1

The correct answer is A. "If a central bank is selling its own currency in the foreign exchange market, then it must have a fixed exchange rate"

Central bank engage in the Foreign exchange market to buy and sell currency to maintain the peg.

Part 2

The correct answer is C. " The money supply will contract and the currency will rise in value."

When central bank sells domestic bonds in the market it sucks out the excess money from the financial market, at the same time selling foreign currency and buying own currency will result in rise in value of domestic currency.

Part 3

The correct answer is A. "The currency will depreciate as both of these actions cause the money supply to increase"

Selling its own currency in Forex market will result in increase in supply of currency, and at the same time purchasing domestic bonds and realising money in the market will depreciate the currency as supply outpace the demand.