Question : In a floating exchange rate system, exchange rates are determined by:
Option 1: Market forces of supply and demand
Option 2: Government intervention
Option 3: Central bank policies
Option 4: Fixed exchange rates
Correct Answer:
Market forces of supply and demand
Solution : The correct answer is a) Market forces of supply and demand
In a floating exchange rate system, exchange rates are primarily determined by market forces of supply and demand. The exchange rate between two currencies in a floating system is determined by the interactions of buyers and sellers in the foreign exchange market. Factors such as trade flows, capital flows, interest rate differentials, economic indicators, geopolitical events, and market expectations influence the demand for and supply of currencies, thereby affecting their exchange rates.
Unlike in fixed exchange rate systems, where governments or central banks intervene to maintain specific exchange rates, in a floating exchange rate system, exchange rates are allowed to freely fluctuate based on market dynamics. The flexibility of a floating exchange rate system allows for adjustments to changing economic conditions and enables market participants to respond to economic factors and market forces.
