The exchange rate is Rs 80 to a pound. Investors expect the pound to be worth Rs 84 by the end of the month. An investor buys pounds now with Rs 1,20,000 and plans to sell them at the end of the month. What profit does she expect, and what happens to the rupee-pound exchange rate now when many investors act like her?
Answer & explanation
Correct answer: option 3
The correct answer is Option (3) → Rs 6,000; the rate rises now
Investors hold pounds when they expect to gain from the pound’s appreciation. Their buying itself raises the demand for pounds today.
Given:
Rate now = Rs 80 per pound
Expected rate = Rs 84 per pound
Amount = Rs 1,20,000
\( \displaystyle \text{Pounds bought} = \frac{1{,}20{,}000}{80} = 1{,}500 \)
\( \displaystyle \text{Value at the end of the month} = 1{,}500 \times 84 = 1{,}26{,}000 \)
\( \displaystyle \text{Profit} = 1{,}26{,}000 - 1{,}20{,}000 = 6{,}000 \)
She expects a profit of Rs 6,000. As investors buy pounds, the rupee-pound rate rises now, so the belief becomes self-fulfilling.
Option (1) Rs 4,000; the rate rises now — Incorrect. Rs 4,000 is a gain of Rs 4 a pound on only 1,000 pounds. Rs 1,20,000 buys 1,500 pounds.
Option (2) Rs 6,000; the rate falls now — Incorrect. The profit is right, but more demand for pounds raises their price in rupees; it does not lower it.
Option (4) Rs 4,000; the rate falls now — Incorrect. Both parts are wrong: the profit is Rs 6,000, and the rate rises.
NCERT (2026-27): “Speculation Money in any country is an asset. If Indians believe that British pound is going to increase in value relative to the rupee, they will want to hold pounds. Thus exchange rates also get affected when people hold foreign exchange on the expectation that they can make gains from the appreciation of the currency. This expectation in turn can actually affect the exchange rate in the following way. If the current exchange rate is Rs. 80 to a pound and investors believe that the pound is going to appreciate by the end of the month and will be worth Rs.85, investors think if they gave the dealer Rs. 80,000 and bought 1000 pounds, at the end of the month, they would be able to exchange the pounds for Rs. 85,000, thus making a profit of Rs. 5,000. This expectation would increase the demand for pounds and cause the rupee-pound exchange rate to increase in the present, making the beliefs self-fulfilling.” |