Question

When the foreign exchange rate of a country is determined by market forces, then what is this type of exchange rate called?

• A. Fixed exchange rate
• B. Flexible exchange rate
• C. Managed floating exchange rate
• D. All of these

Hint:

A flexible exchange rate is set by the market, where currency values fluctuate based on supply and demand.

Answer 1

The Correct Option is B

Step 1: Understanding Exchange Rate Systems:
Exchange rate systems determine how the value of a country's currency is set relative to other currencies. There are three primary types: fixed exchange rate, flexible exchange rate, and managed floating exchange rate.
Step 2: Analyzing the Options:
- Option (A) Fixed exchange rate: In a fixed exchange rate system, the government sets the value of the currency and maintains it by buying or selling foreign currencies. It is not determined by market forces.
- Option (B) Flexible exchange rate: This is the correct answer. A flexible exchange rate is determined by the market forces of supply and demand for currencies. The central bank does not intervene to set the exchange rate.
- Option (C) Managed floating exchange rate: In this system, the exchange rate is primarily determined by market forces, but the central bank may intervene occasionally to stabilize the currency. It’s not purely market-determined.
- Option (D) All of these: This is incorrect because only the flexible exchange rate is entirely determined by market forces.
Step 3: Conclusion and Answer:
The correct answer is (B) because a flexible exchange rate is one that is entirely determined by market forces of supply and demand, with no fixed value set by the government.