How do international investment activities affect exchange rates?

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How do international investment activities affect exchange rates?

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How do international investment activities affect exchange rates?

Explanation & AnswerSolution by a verified expert

Explanation

International investment activities consist of direct investments and portfolio investments. Direct investments include purchase of stakes in foreign companies or setting up of new business in foreign countries, whereas portfolio investment means purchase of foreign securities. Any type of investment in the foreign requires the investor company to have the funds in the currency of the respective foreign country. Increase in foreign investment in home countries leads to increase in demand of home currency. Thus it appreciates the value of home currency vis-a-vis foreign currency, thereby increasing the exchange rate. On the other hand, an increase in foreign investment in foreign countries leads to an increase in demand of foreign currency by the home country. Thus it appreciates the value of foreign currency in vis-a-vis home currency, thereby decreasing the exchange rate. Thus, changes in international investment activities have a direct and substantial effect on exchange rates.

Verified Answer

International investment activities increase as well as decrease the exchange rate. Increase of foreign investment in the home country increases the exchange rate, whereas increasing foreign investments in foreign decreases the exchange rate.

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