NCERT MOST IMPORTANT QUESTIONS CLASS – 12 | MACROECONOMICS IMPORTANT QUESTIONS | FOREIGN EXCHANGE RATE | EDUGROWN |

In This Post we are  providing FOREIGN EXCHANGE RATE NCERT MOST IMPORTANT QUESTIONS for Class 12 which will be beneficial for students. These solutions are updated according to 2021-22 syllabus. These MCQS  can be really helpful in the preparation of Board exams and will provide you with a brief knowledge of the chapter

NCERT MOST IMPORTANT QUESTIONS ON FOREIGN EXCHANGE RATE

1. Distinguish between devaluation and depreciation of domestic currency.
Difference between devaluation and depreciation

Basis	Devaluation	Depreciation
Meaning	Devaluation is the fall in the value of domestic currency in relation to foreign currency. It is planned by the Central Bank in situation, when exchange rate is not determined by the forces of demand and supply.	It occurs when the value of domestic currency decreases in relation to the value of foreign currency in the foreign exchange market.
Example	A government has set 10 units of its currency is equal to one dollar.	If US $ exchanges ? 45 instead of ? 40 earlier the domestic currency (Indian rupee) has shown depreciation of domestic currency.

2. Giving two examples, explain why there is a rise in demand for a foreign currency
when its price falls?
Ans. (i) when there is a fall in the price of foreign currency, the import gets cheaper. It encourages the importers to import more and consequently, the demand for that foreign currency increases.
(ii) When the price of a foreign currency falls, the price of foreign assets also falls. It encourages domestic people and companies to buy foreign assets and consequently, the demand for that foreign currency increases.

3. Distinguish between fixed and flexible foreign exchange rate.
Ans. Fixed exchange rate is the system, under which the central authority or government maintains their exchange rate fixed either against gold or some other foreign currency. Whereas the rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as flexible exchange rate.

4. Give meanings of fixed, flexible and managed floating exchange rates.

Ans. Fixed and flexible exchange rate
(i) Minimise exchange rate fluctuations
(ii) Reduces volatility and fluctuations in prices
(iii)Imposes discipline on the monetary authority
(iv) Encourages international trade and investment flows
(v) Less speculation in the currency market
The rate of exchange which is determined by the market forces of demand and supply of foreign currencies in the foreign exchange market, is termed as flexible exchange rate system.
Managed floating exchange rate The system of adjusting the exchange rates as per the rules and regulations of foreign exchange market is termed as managed floating.

5. What is meant by appreciation and depreciation of domestic currency? Explain. (All India 2010)
Ans. When the value of domestic currency increases in relation to a foreign currency due to demand and supply forces in a free market, it is termed as appreciation of the domestic currency.
Depreciation of the domestic currency occurs when the value of domestic country’s currency decreases in relation to the foreign currency.
For example, Increase in exchange rate is currency depreciation and decrease in exchange rate is currency appreciation.
(i) When Rs./$ exchange rate falls from 55 to 50 , it is termed as appreciation of domestic currency (i.e. Indian rupee) –
(ii) When Rs./$ exchange rate rises from 50 to 55, it is termed as depreciation of domestic currency .

6. Explain the meaning and two merits of fixed foreign exchange rate.
Ans.Fixed foreign exchange rate
(i) Minimise exchange rate fluctuations
(ii) Reduces volatility and fluctuations in prices
(iii)Imposes discipline on the monetary authority
(iv) Encourages international trade and investment flows
(v) Less speculation in the currency market
Two merits of fixed foreign exchange rate are:
(i) Less speculation in the currency market.
(ii) Encourages international trade and investment flows.

7. State two sources each of demand and supply of foreign exchange.
Ans. Two sources of demand for foreign exchange are:
(i) Imports from rest of the world.
(ii) Foreign investment across the world.
Two sources of supply of foreign currency are:
(i) Exports of goods and services from domestic country to foreign country .
(ii) Remittances from abroad.
4 Mark Questions

8. Explain two merits each of fixed exchange rate and flexible exchange rate. 
Ans. Merits of fixed exchange rate are as follows:
(i) Minimises exchange rate fluctuations.
(ii) Encourages international trade and investment flows.
Merits of flexible exchange rate are as follows:
(i) Independent monetary policy.
(ii) No need to maintain huge stock of gold or other currency.

9. How is foreign exchange rate is determined in the market?
Foreign exchange rate is determined by the market forces of demand and supply in foreign exchange market. The point where demand and supply of foreign exchange meet, gives the equilibrium rate of exchange

In the above figure, D stands for the demand for foreign exchange and 5 curve represents the supply of foreign exchange for different values of R i.e. rate of exchange. Point E is the equilibrium point, where D =5, so R will be the rate of exchange. If the rate of exchange is arbitrarily fixed other than R, there wi 11 be a situation of either excess demand or excess supply of foreign exchange, so R is the rate of exchange which is obtained from the equilibrium point E. Any disequilibrium will be adjusted automatically by the forces of demand and supply of foreign exchange to attain equilibrium.
6 Mark Question

10. Give the meaning of foreign exchange and foreign exchange rate. Giving reason, explain the relation between foreign exchange rate and demand for foreign exchange.

Ans. Foreign exchange Foreign exchange rate is determined by the market forces of demand and supply in foreign exchange market. The point where demand and supply of foreign exchange meet, gives the equilibrium rate of exchange as shown in figure and quantity of foreign exchange.

Foreign exchange rate Foreign exchange rate refers to the rate at which one currency can be exchanged for the other currency in foreign exchange market, e.g. if Rs. 58 is paid to buy one US dollar, then Rs./$ exchange rate will be 58 i.e. Rs.58 per dollar.

Relation between foreign exchange rate and demand for foreign exchange There is an inverse relationship between the foreign exchange rate and demand for foreign exchange, with the rise in foreign exchange rate, demand for foreign exchange falls and vice-versa.

In the above figure, D curve represent the demand for foreign currency. When exchange rate is high (R1), demand for the foreign currency falls (Q1,). On the other hand, when exchange rate is low (R₂), demand for the foreign currency rises Q₂. The demand curve for the foreign currency is always downward sloped and signifies an inverse relationship between demand and exchange rate i.e. price of foreign exchange.