Question : Which of the following factors can influence foreign exchange rates in the long run?

Option 1: Speculation in the foreign exchange market
  

Option 2: Political events and stability
 

Option 3: Short-term interest rate differentials

 

Option 4: Currency arbitrage

Correct Answer: Political events and stability

Solution : The correct answer is b) Political events and stability

Political events and stability can have a significant influence on foreign exchange rates in the long run. Changes in government, political stability, geopolitical tensions, and policy decisions can impact investor confidence and perception of a country's economic prospects. Political instability or uncertainty can lead to a loss of confidence in a country's currency, resulting in depreciation. Conversely, political stability and positive policy measures can attract investment and contribute to currency appreciation.

Speculation in the foreign exchange market, c) Short-term interest rate differentials, and d) Currency arbitrage are factors that can influence foreign exchange rates in the short to medium term. Speculation in the foreign exchange market involves traders and investors buying or selling currencies based on their expectations of future price movements. Short-term interest rate differentials, which are the differences in interest rates between currencies, can impact capital flows and currency demand. Currency arbitrage refers to taking advantage of price discrepancies between different currency markets to make profits. While these factors can contribute to fluctuations in foreign exchange rates in the short run, their impact on long-term exchange rate movements is generally limited compared to factors such as political events and stability.