When Exchange Rates Are Fixed and the Foreign Nation's Interest

question 73

Multiple Choice

When exchange rates are fixed and the foreign nation's interest rate increases, what happens next?

• A) The home nation's IS curve shifts out because of a depreciation and an increase in the trade balance.
• B) The home nation's LM curve shifts right, and its interest rate falls.
• C) Fixed exchange rates force the home nation to raise its interest rates.
• D) The home nation and the foreign nation are always in equilibrium, so no changes occur.

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Definitions:

Components

Parts or elements that make up a larger system or compound.

Commercial Substance

A transaction has commercial substance if it significantly changes the company's future cash flows.

Depreciated

A reduction in the value of an asset over time, due in particular to wear and tear.

Interest Capitalization

The process of adding interest that has accumulated on a loan to the principal balance of the loan, effectively increasing the total amount owed.