An article in the Wall Street Journal contained the following observations on fo

Question

An article in the Wall Street Journal contained the following observations on foreign exchange market:

Many eyes in currency markets Friday were on Mexico, where dollar fell below 10 pesos for the first time since October 2002….The peso’s rise to its strongest level in nearly six years has been largely attributed to the widening of yield spreads—U.S. interest rates have been kept low to counter economic weakness, and Bank of Mexico has raised rates to keep inflation expectations in check.

Over in Australia, however, the U.S. dollar came out on the winning end Friday. Australia dollar fell to 2 months low of US$0.9298 Friday as investors began betting that Australia’s central bank may reduce its relatively high lending rate   before the end of the year.

Why would interest rates in Mexico being higher than interest rates in United States cause pesos to be high relative to the U.S. dollar? Why would the expectations that Australia’s central bank will reduce its lending rates cause the value of the Australia dollar to fall relative to the value of US dollars?  

in Microsoft word format ( not handwritten )

Explanation / Answer

Interest rates being higher in Mexico than in US will lead pesos to be high relative to us dollar because higher interest rates attract capital from USA. Investors invest in Mexico to take benefit of higher interest rates there. Investment in Mexico can be made in terms of pesos. The demand for pesos rise given the supply. Thus price of pesos rises. Price price of pesos is dollars here. Thus more dollars will be required to purchase pesos. Thus peso is high relative to dollar

The expected action of Australian central bank cause the value of Australian dollar to fall relative to us dollars because speculators know if the Australia's central bank will reduce its lending rate in reality there will be movement of capital from Australia to usa where interest rates are relatively higher. As a result Australian Dollar is expected to fall. Those who possess Australian Dollar are expected to loose because more Australian dollars will be needed to purchase us dollar. Thus speculators transfer Australian dollars into us dollars. This leds to greater supply of Australian dollars and less demand for Australian dollars. Thus value of Australian Dollar will fall

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