How will an interest rate increase in Canada affect equilibrium in the market for Canadian dollars against foreign currencies? (Assume the exchange rate is stated in terms of foreign currency per Canadian dollar.)
A)The equilibrium exchange rate will increase, and the equilibrium quantity of dollars traded cannot be determined.
B)The equilibrium exchange rate will decrease, and the equilibrium quantity of dollars traded cannot be determined.
C)The equilibrium exchange rate cannot be determined, and the equilibrium quantity of dollars traded will increase.
D)The equilibrium exchange rate will increase, and the equilibrium quantity of dollars traded will increase.
E)The equilibrium exchange rate and the equilibrium quantity of dollars traded cannot be determined.

Question

Quizplus · Accepted Answer

An increase in interest rates in Canada would make Canadian dollars more attractive to foreign investors seeking higher returns, increasing the demand for Canadian dollars in foreign exchange markets. As a result, the value of the Canadian dollar would increase relative to foreign currencies, meaning that fewer foreign currencies would be needed to purchase each Canadian dollar. This would lead to an increase in the equilibrium exchange rate, while the equilibrium quantity of dollars traded cannot be determined without more information.

How Will an Interest Rate Increase in Canada Affect Equilibrium