Assume that britain and the u. s. conduct a large volume of international trade, but rarely engage in financial flows. conversely, japan and the u. s. conduct a large volume of financial flow transactions, but rarely engage in trade flows. under this scenario, everything else held constant, a change in the u. s. would affect the value of the pound, and a change in the u. s. would affect the value of the yen. a. interest rate; income level b. interest rate; inflation rate c. [interest rate; inflation rate] and [interest rate; income level] d. inflation rate; interest rate e. none of these choices are correct.

It is important to define some basic concepts. Inflation means the lowering of the value of money due to time; it can be attributed to the fact that as the standards of life are rising, commodities' prices also rise. The interest rate is indicative of how much profit one can have on a specific amount of money in the period of one year (if this weren't the case, we would all invest our money than keep it at the bank). Thus a change in the interest rate in US, the pound would not be affected since Dollars are not converted to Pounds this way; but a change in the inflation rate would mean that the pound could buy more products from the US. Similarly, since there are a lot of financial trades between the US and Japan, a change in the inflation rate in either of these countries would not affect their currencies. But a change in the interest rate would change a lot. Thus, the rifht answer is d. (Income level is rather irrelevant).