Capital Flight and Foreign Exchange Markets

Question

In response to perceived risks in the domestic banking system, investors may shift their assets away from domestic bonds. How is this reflected in the foreign exchange market?

Accepted Answer

The demand curve for domestic currency shifts left as foreign investors reduce their holdings of domestic assets.

Answer

The supply curve for domestic currency shifts left since banks retain more funds for liquidity.

Answer

There is no effect on the foreign exchange market because bank risk does not influence currency flows.

Answer

The demand curve for domestic currency shifts right because investors seek safe haven assets in domestic bonds.