Question : What is the main function of a central bank in relation to foreign exchange rates?
Option 1: To set interest rates
Option 2: To regulate commercial banks
Option 3: To maintain price stability
Option 4: To intervene in the foreign exchange market
Correct Answer: To intervene in the foreign exchange market
Solution : The correct answer is d) To intervene in the foreign exchange market
The main function of a central bank in relation to foreign exchange rates is to intervene in the foreign exchange market. Central banks have the authority and capability to buy or sell currencies in order to influence the exchange rate and stabilize or manage the currency's value.
Central banks may intervene in the foreign exchange market to achieve various objectives. For example, they may intervene to prevent excessive volatility, smooth out abrupt currency movements, or address situations where the currency is overvalued or undervalued. Interventions can involve buying or selling the domestic currency, using foreign reserves held by the central bank.
By intervening in the foreign exchange market, central banks can influence the supply and demand for a currency, which can affect its value relative to other currencies. However, it's important to note that the specific policies and approaches of central banks regarding foreign exchange intervention can vary across countries and depend on their respective monetary policy frameworks and economic goals.
