Final answer:
A higher rate of return in a nation's economy typically strengthens its currency because it attracts foreign investment, which increases demand for the nation's currency.
Step-by-step explanation:
Yes, a higher rate of return in a nation's economy does affect the exchange rate of its currency. When a country offers higher rates of return compared to other countries, it tends to attract foreign funds. As a result, demand for that country's currency increases as investors seek to buy interest-bearing assets in that currency. Conversely, if investment returns in a country are low, capital will flow to countries with higher returns. This shifting demand and supply can cause the currency to appreciate or strengthen if returns are high, and depreciate or weaken if returns are low.
For example, if interest rates rise in the United States compared to Mexico, the demand for U.S. dollars would increase among investors for the purpose of taking advantage of the higher returns, and the supply of U.S. dollars to foreign exchange markets would decrease. This shift would likely lead to an appreciation of the U.S. dollar compared to the Mexican peso.