Question

Who determines the exchange rate between the currencies of two countries?

• A. World Bank
• B. Demand and Supply of Currencies
• C. International Monetary Fund (IMF)
• D. Central Bank

Hint:

Just like the price of any good (like apples) is determined by its demand and supply in the market, the price of a currency (the exchange rate) is also determined by the demand for and supply of that currency.

Answer 1

The Correct Option is B

Step 1: Understanding the Concept:
The exchange rate is the price of one currency in terms of another. The question asks for the fundamental determinant of this rate.

Step 2: Detailed Explanation:
In a flexible (or floating) exchange rate system, which is the most common system today, the exchange rate is determined by the market forces of supply and demand in the foreign exchange market. \begin{itemize} \item The demand for a currency is created by foreigners who want to buy that country's goods, services, or assets. \item The supply of a currency is created by domestic residents who need foreign currency to buy foreign goods, services, or assets. \end{itemize} The equilibrium exchange rate is the rate at which the quantity of a currency demanded equals the quantity supplied.
While the Central Bank (D) can intervene in the market to influence the rate (in a managed float system) and the IMF (C) and World Bank (A) play roles in the international financial system, the fundamental determinant in a market-based system is the interaction of demand and supply.

Step 3: Final Answer:
The exchange rate between currencies in a flexible system is determined by the market forces of demand and supply. Therefore, option (B) is the most accurate and fundamental answer.