Consider the following statements:1. Tight monetary policy of the US Federal Reserve could lead to capital flight.2. Capital flight may increase the interest cost of firms with existing External Commercial Borrowings (ECBs).3. Devaluation of domestic currency decreases the currency risk associated with ECBs.Which of the statements given above are correct?
✓ Correct answer: a) 1 and 2 only
ExplanationStatement 1 is correct: A tight monetary policy by the US Federal Reserve typically involves incre-asing interest rates to control inflation.Higher US interest rates can attract investors seeking better returns which can lead to capital outflows from emerging markets as investors move their funds to the US.This phenomenon is known as capital flight.Statement 2 is correct: Capital flight can lead to the depre- ciation of the domestic currency as investors sell off local assets.For firms with ECBs(loans in foreign currency) denom- inated in foreign currencies, a weaker domestic currency means that more local currency is required to service the same amount of foreign debt, effectively increasing the interest cost and principal repayments in domestic currency terms.Statement 3 is incorrect : Devaluation increases(not de- creases) the currency risk associated with ECBs.If a firm has borrowed in a foreign currency and the domestic currency is devalued, the firm will have to pay more in domestic currency terms to repay the loan.This increases the burden of the debt and the currency r
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