Final answer:
The value of a country's currency is determined by supply and demand in the foreign exchange market. Interest rates and rates of return are significant factors that influence the demand for a currency, consequently affecting the exchange rate. High interest rates attract foreign investments and increase currency value, while low rates can lead to depreciation. The correct option is O supply and demand.
Step-by-step explanation:
The factors that play a role in establishing the value of a country’s currency are supply and demand. The value of a currency is determined in the foreign exchange market, where currencies are traded for one another and their relative values are expressed in exchange rates. Changes in exchange rates are influenced by various economic factors, such as differences in interest rates and rates of return across countries.
When the anticipated rates of return in a country are high compared to other countries, it attracts foreign investment, which increases demand for that country’s currency. For instance, if interest rates rise in the United States relative to Mexico, investors would prefer to hold U.S. assets, thus increasing the demand for U.S. dollars. This causes the supply of U.S. dollars in foreign exchange markets to decrease and the demand to increase, ultimately leading to an appreciation of the U.S. dollar.
Central banks can influence these rates through monetary policy, such as by changing domestic interest rates. A higher interest rate offers better returns on savings and investments, leading to increased demand for that country's currency and an appreciation of its value. Conversely, low interest rates can result in depreciation. The exchange rate is an essential factor in international trade as it impacts the affordability and competitiveness of a country's goods and services on the global market.