Question

Choose the correct statements regarding the exchange rate system:

• [(A)] In a floating exchange rate system, the exchange rate is determined by market forces of demand and supply.
• [(B)] In a fixed exchange rate system, making the domestic currency cheaper is called devaluation.
• [(C)] An increase in the exchange rate implies that the price of foreign currency has increased, which is called depreciation.
• [(D)] Exchange rates between two currencies adjust to reflect differences in price levels in the two countries.

• A. (A), (B) and (C) only
• B. (A), (B) and (D) only
• C. (B), (C) and (D) only
• D. (A), (B), (C) and (D)

Hint:

Remember:

• Floating exchange rate $\rightarrow$ Market determined
• Fixed exchange rate $\rightarrow$ Government intervention
• Devaluation $\rightarrow$ Official reduction in currency value
• Depreciation $\rightarrow$ Market-driven fall in currency value

Answer 1

The Correct Option is D

Concept: Exchange rate systems determine how the value of one currency is measured against another currency in international trade and finance.

Step 1: Examine Statement (A). In a: \[ \text{Floating Exchange Rate System} \] exchange rates are determined by: \[ \text{Demand and Supply forces} \] Thus: \[ (A) \text{ is correct} \]

Step 2: Examine Statement (B). Under a: \[ \text{Fixed Exchange Rate System} \] if the government officially reduces the value of domestic currency, it is called: \[ \text{Devaluation} \] Thus: \[ (B) \text{ is correct} \]

Step 3: Examine Statement (C). If the exchange rate rises: \[ \text{More domestic currency is required to buy foreign currency} \] This means domestic currency loses value, which is called: \[ \text{Depreciation} \] Thus: \[ (C) \text{ is correct} \]

Step 4: Examine Statement (D). According to: \[ \text{Purchasing Power Parity (PPP)} \] exchange rates adjust based on: \[ \text{Differences in price levels between countries} \] Thus: \[ (D) \text{ is correct} \] Hence, all statements are correct. Therefore, \[ \boxed{(A),\ (B),\ (C)\ \text{and}\ (D)} \]