#1. Australia runs a fixed exchange rate regime. You work for a hedge fund. You, and many other traders in the hedge fund community, believe that Australia is about to revalue its currency (the AUD) against the US dollar.

Thus, you believe that the AUD will become stronger against the US dollar in the future, although the current spot exchange rate remains unchanged.

Which of the following is likely to occur?

A. Hedge funds will take short positions in the AUD, the money supply will decline, and foreign exchange reserves will fall.

B. Hedge funds will take short positions in the AUD, the money supply will increase, and foreign exchange reserves will rise.

C. Hedge funds will take long positions in the AUD, the money supply will decline, and foreign exchange reserves will fall.

D. Hedge funds will take long positions in the AUD, the money supply will increase, and foreign exchange reserves will rise.

#2. Continuing with the scenario described in the previous question, suppose hedge funds believe the revaluation will occur within the next year. Which of the following is likely to occur with the one-year AUD forward exchange rate, and the one-year Australian interest rate?

The AUD forward rate will appreciate, and Australian interest rates will rise.

The AUD forward rate will appreciate, and Australian interest rates will fall.

The AUD forward rate will depreciate, and Australian interest rates will rise.

The AUD forward rate will depreciate, and Australian interest rates will fall.