Module: | MODULE A: INTERNATIONAL BANKING
Q1: Read the following statements regarding the structure of the global foreign exchange market and the macroeconomic factors determining exchange rates. Identify the correct combination.
Statement 1. The global foreign exchange market is a decentralized, over-the-counter market operating without a single physical centralized clearinghouse.
Statement 2. According to the Purchasing Power Parity theory, a significantly higher inflation rate in India relative to the United States will typically lead to the appreciation of the Indian Rupee against the US Dollar over the long term.
Statement 3. An aggressive increase in the benchmark domestic interest rate by the Reserve Bank of India generally attracts foreign capital inflows, leading to a short-term appreciation of the domestic currency.
Statement 2. According to the Purchasing Power Parity theory, a significantly higher inflation rate in India relative to the United States will typically lead to the appreciation of the Indian Rupee against the US Dollar over the long term.
Statement 3. An aggressive increase in the benchmark domestic interest rate by the Reserve Bank of India generally attracts foreign capital inflows, leading to a short-term appreciation of the domestic currency.
✅ Correct Answer: B
🎯 Quick Answer:
Option B is the correct choice because Statement II is conceptually flawed.Structural Breakdown: Statement I is correct.
Unlike equity markets, the forex market is an Over-The-Counter market.
It operates 24 hours a day through an electronic network of banks, corporations, and individuals without a central physical trading floor.
Statement II is incorrect.
The Purchasing Power Parity theory states that exchange rates adjust to offset differences in inflation between two countries.
High inflation in India erodes the purchasing power of the Rupee.
Therefore, higher inflation in India relative to the United States leads to the depreciation, not appreciation, of the Indian Rupee against the US Dollar.
Statement III is correct.
When the Reserve Bank of India raises interest rates, domestic debt instruments yield higher returns.
This attracts foreign institutional investors looking for yield, increasing the demand for the Indian Rupee, and causing it to appreciate in the short term.
Historical and Related Context: Central banks heavily monitor these dual factors, inflation and interest rates, to manage their currency strength in global trade.