Macro

Balance of Payments

Easy

Comprehension:

THE FOREIGN EXCHANGE MARKET

The market in which national currencies are traded with one another is known as the foreign exchange market. The major participants in the foreign exchange market are commercial banks, foreign exchange brokers and other authorized dealers and monetary authorities. It is important to note that although participants themselves may have their own trading centers, the market itself is world-wide. There is close and continuous contact between the trading centers and the participants deal in more than one market.

Foreign currency flows into the home country for the following reasons: exports by a country lead to the purchase of its domestic goods and services by foreigners; foreigners send gifts or make transfers; and, the assets of a home country are bought by foreigners. A rise in the price of foreign exchange will reduce foreigners’ costs while purchasing products from India and other things will remain constant. This increases India’s exports and hence the supply of foreign exchange may increase.

Different countries have different methods of determining their currency’s exchange rate. It can be determined through Flexible Exchange Rate, Fixed Exchange Rate or Managed Floating Exchange Rate. Floating exchange rate is determined by the market forces of demand and supply. Where fixed exchange rate is determined by the government at a particular level. In floating exchange rate increasing value of currency is known as appreciation and a decreasing value is known as devaluation where in fix exchange rate decreased value is known as devaluation. Managed floating exchange rate is combination of flexible and fixed exchange rate where at certain movement central intervene through market operation to manage currency exchange rate.

An increase in exchange rate implies that the price of foreign currency in terms of domestic currency has increased; this is called ........

Appreciation of the domestic currency.

Devaluation of domestic currency.

Depreciation of domestic currency.

Dirty floating.

✅ Correct Option: 3

Option 1 -> When domestic currency appreciates, fewer units are needed to buy foreign currency, meaning the price of foreign currency decreases.

Option 2 -> Devaluation is a deliberate policy action by authorities to reduce currency value under a fixed exchange rate system.

Option 3 -> Depreciation occurs when domestic currency loses value in a floating system, requiring more units to purchase foreign currency.

Option 4 -> Dirty floating is an exchange rate regime with market-determined rates and occasional intervention, not a description of currency value change.

Hence, Depreciation of domestic currency -> When the exchange rate increases, meaning the price of foreign currency rises in terms of domestic currency (e.g., 1 USD = 70 INR becomes 1 USD = 75 INR), the domestic currency has weakened or depreciated. This means more domestic currency is required to purchase the same amount of foreign currency, indicating a loss in the domestic currency's purchasing power in international markets. This naturally occurs in floating exchange rate systems due to market forces of demand and supply. -> correct

Question 47

When the central bank intervenes to control the exchange rate through sell/purchase of foreign currencies, this process is called______

Question 48

In an economy, to control a high balance of payment problem if government decided to reduce its currency value against globally accepted foreign currency, this process this known as:

Question 49

When income increases and due to increase in income the demand for foreign goods increases then in this scenario what impact does economy face on foreign exchange rate ?

Question 50

The place where currencies are traded is known as .........

An increase in exchange rate implies that the price of foreign currency in terms of domestic currency has increased; this is called ........

Solution

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