Question

As a foreign exchange trader, how would you react to each of the following news items as it flashes on your computer screen? (Will you sell the foreign currencies you have or buy more foreign currencies?) Explain how the nominal exchange rate will change in each case using the Net Exports-Net Capital Outflows Model.Your score is based on your explanation. Please attach graphs as a Word document or pictures.

a. Mexico’s oil reserves prove to be much smaller than touted earlier.

b. The Social Credit Party wins the national elections in Canada and promises generous expansion of the supply of money and credit.

c. The Japanese government passes a law that will result in a large increase in the taxation of interest payments from Japan to foreigners.

Answer 1

1. Mexico’s oil reserves prove to be much smaller than touted earlier.

Answer : In this case, I would decide to sell the foreign currency. As per previous expectations, having a large sum of oil reserve would have benefited the foreign investors. However, as the world market is aware about the less reserve of oil, it will lead to foreign stakholders selling their shares to avoid making loss.

2.  The Social Credit Party wins the national elections in Canada and promises generous expansion of the supply of money and credit.

Answer : IN this scenario, being a foreign investor, I would buy more foreign currency as the availability of the money and credit has increased in the market. It will increase the average person expenditure capacity which would increase in more demand than supply. And as the economics 101 suggests, the more the demand, the higher the GDP and higher the market will rise. Hence, investing by buying more currency will definetely be the next step.

3.  The Japanese government passes a law that will result in a large increase in the taxation of interest payments from Japan to foreigners.

Answer : This step would lead the foreign investors to sell their stake or currency as they will have to bear the high tax interest rate . This would mean, less profits for foreign investors and they would not like to continue loosing profits over taxed interest.