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1. The passage suggests which of the following about the role of foreign investment in the Asian financial crisis of the 1990s?

A. Regulation of foreign investment through capital controls would likely have exacerbated the crisis.
B. Direct investment was a determining factor that led to large swings in foreign exchange markets.
C. Its role in financial crises may be mitigated through public policy.
D. It resulted in the growth of institutions shielded from systemic failure by implicit government support.
E. Countries that allow currencies to be determined by market forces create more favorable environments for foreign investment.

Official Explanation

The phrase the passage suggests in the question stem indicates that this is an inference question. The task of the question is indicated by the word suggests. The subject of the question is something about the role of foreign investment in the Asian financial crisis of the 1990s. In order to answer the question, determine what the passage states about the subject and evaluate the answer choices, eliminating any choice that cannot be supported by the text. According to the passage, the study showed that a surge in foreign direct investment did not predict large swings in foreign exchange markets of the underlying currencies. Rather, authors of the study suggested an alternative explanation – that the collapse was due to structural weaknesses. The passage goes on to state that one factor contributing to financial instability was the belief that governments would provide support in the event of systemic failure, and therefore governments in developing nations should prioritize establishing a strong regulatory structure rather than providing rescue packages.

Choice A: No. This choice may seem appealing due to the recycled language exacerbated and foreign investment, but it is a reversal of one of the key points of the passage. One of the recommendations made by the author of the passage is that governments in developing nations should prioritize establishing a strong regulatory structure rather than providing rescue packages. This implies that stronger regulation could have mitigated, not exacerbated the crisis.

Choice B: No. The recycled language foreign exchange markets may make this choice tempting. However, this answer is a reversal. The author of the passage introduces the perspective that direct investment destabilized currency markets in order to contradict it with the study that is described in the latter part of the passage. The study concluded that a surge in foreign direct investment did not predict large swings in foreign exchange markets of the underlying currencies.

Choice C: Correct. This choice is supported by the passage. This answer refers to the two public policy recommendations made in the passage, that governments in developing nations should prioritize establishing a strong regulatory structure rather than providing rescue packages and governments and regulators should allow currency rates to be determined by market forces rather than arbitrarily peg their values to a reserve currency or basket of currencies. The author suggests that these policies may mitigate the impact of financial crises.

Choice D: No. This choice may seem appealing because it includes two topics discussed at length in the topic, which are foreign direct investment and the growth of institutions shielded from systemic failure by implicit government support. However, this choice is a memory trap. The passage does not draw a causal relationship between foreign investment and the growth of such institutions.

Choice E: No. This choice may seem tempting because the author recommends that governments and regulators should allow currency rates to be determined by market forces rather than arbitrarily peg their values to a reserve currency or basket of currencies, and the author discusses foreign investment. However, the author makes no such comparison between the environment for foreign investment and freely floating currencies, but rather makes the recommendation that freely floating currencies may help mitigate the severity of financial crises in developing markets.

The correct answer is choice C.