Explanation

Expansionary fiscal policy typically involves increased government spending or tax cuts, which can:

• Increase domestic demand
• Potentially lead to higher interest rates due to increased borrowing
• Attract foreign capital seeking higher returns

When capital flows are highly sensitive to interest rate differentials (Option C), the higher domestic interest rates resulting from expansionary fiscal policy will attract significant foreign capital inflows. This increased demand for the domestic currency causes it to appreciate.

In contrast:

• Immobile capital (Option A) would not respond to interest rate changes
• Insensitive capital flows (Option B) would not significantly respond to interest rate differentials

Correct Answer: C - Highly sensitive to interest rate differentials.