A speculative attack involves mass sales of a ________ currency and purchases of a ________ one, under a ________ exchange rate system.

Question

BlackTom AI · Accepted Answer

Speculative attacks target a fixed exchange-rate regime by betting that the pegged (overvalued) domestic currency will be forced to depreciate, so speculators sell that weak domestic currency and buy a stronger foreign currency.

1) Relevant concepts
- Fixed (pegged) exchange rate: the monetary authority commits to a specific rate and must intervene (using foreign reserves) to maintain it.
- Speculative attack: large-scale selling of a currency that investors expect will be devalued; attackers convert into a perceived stronger currency.
- Central-bank defense: to defend a peg the central bank buys its own currency using foreign reserves; if reserves run out the peg breaks.

2) Step-by-step reasoning
- Suppose a domestic currency is perceived as overvalued (thus effectively weak in fundamentals) under a fixed peg.
- Speculators anticipate a devaluation, so they sell the domestic (weak) currency en masse and purchase foreign (strong) currency.
- This sudden selling pressure forces the central bank to use foreign reserves to buy its own currency to uphold the peg.
- If reserves are insufficient, the peg collapses and the domestic currency depreciates—speculators profit.

3) Calculations / mechanics (conceptual)
- No numeric calculation needed; the mechanism is: Speculators exchange domestic → foreign. Central bank responds: foreign reserves ↓ while domestic currency demand ↑. If foreign reserves → 0, peg collapses.

4) Why the correct answer is correct
- The attack involves sales of the currency expected to fall (weak) and purchases of a stronger foreign currency, and this strategy exploits the commitments and limited reserves inherent in a fixed-rate system.

5) Why other options are incorrect
- b (strong; weak; floating): Wrong direction (selling a strong currency is not the typical attack) and speculative attacks are aimed at fixed pegs, not floating regimes.  
- c (weak; strong; floating): Direction is right but floating exchange rates automatically adjust, so attackers cannot force a central-bank choice the way they can under a peg.  
- d (strong; weak; fixed): Reverses the buy/sell roles; attackers sell the currency they expect to weaken, not a strong one.

Conclusion: The correct choice is a. weak; strong; fixed, which matches the provided answer.

A speculative attack involves mass sales of a currency and purchases of a one, under a exchange rate system.Single choice

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A speculative attack involves mass sales of a ________ currency and purchases of a ________ one, under a ________ exchange rate system.Single choice