Final answer:
When an economy experiences higher real, risk-adjusted interest rates, there is an increase in demand for its currency, resulting in the currency's appreciation. The correct answer is 4) an increase in demand for the currency and an appreciation in its value.
"The correct option is approximately option 4"
Step-by-step explanation:
When an economy sees higher real, risk-adjusted interest rates, it will most likely experience an increase in demand for its currency in the foreign exchange market, and the value of its currency will appreciate. Therefore, the correct answer is 4) increase; appreciate.
An increase in interest rates relative to other countries makes the currency more attractive due to the potential for higher returns on investments denominated in that currency.
As a result, international investors and financial market participants would tend to buy more of the currency, driving up its demand. Conversely, lower interest rates would tend to decrease the currency's value.
Understanding these dynamics involves recognizing the relationship between interest rates, currency demand, and currency value. Higher interest rates attract foreign capital, which increases the demand for the domestic currency, thereby leading to appreciation. On the other hand, expected depreciation in a currency can decrease demand since investors might divest from the currency, leading to a depreciation of the currency in question. Additionally, a country's currency might appreciate if there is a relative decrease in inflation compared to other countries, further affecting demand and supply in the foreign exchange market.