Foreign Exchange Rate Quiz - ICSE Class 12 Economics
Free practice quiz: Foreign Exchange Rate (ICSE Class 12 Economics). 45 multiple-choice questions with answers and explanations. Play online, no sign-up needed.
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When the demand for a country's currency increases, while its supply remains constant, what is the most likely immediate impact on the exchange rate in a floating exchange rate system?
- The currency will depreciate.
- The currency will appreciate.
- There will be no change in the exchange rate.
- The central bank will intervene to stabilize the currency.
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Answer: B. The currency will appreciate.
In a floating exchange rate system, the value of a currency is determined by market forces of supply and demand. An increase in demand for a currency, holding supply constant, signifies that more entities want to acquire that currency. This increased demand will push up its price, leading to appreciation.
Which of the following is a potential consequence of a sharp and unexpected depreciation of a country's currency?
- Lower inflation due to cheaper imports.
- Increased foreign debt burden for domestic entities that borrowed in foreign currency.
- Reduced export competitiveness.
- Higher profits for domestic companies exporting their goods.
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Answer: B. Increased foreign debt burden for domestic entities that borrowed in foreign currency.
When a country's currency depreciates, domestic currency units are worth less in terms of foreign currency. For domestic entities that have borrowed in foreign currency, the amount of domestic currency needed to repay that debt in foreign currency terms increases significantly. This increases the real burden of foreign debt. Cheaper imports would lead to lower inflation, reduced export competitiveness is incorrect (exports become cheaper), and higher profits for exporters is correct, but the question asks for a potential consequence, and the debt burden is a critical one.
A country imports significantly more goods and services than it exports. This situation is known as a:
- Trade surplus
- Current account surplus
- Trade deficit
- Capital account surplus
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Answer: C. Trade deficit
A trade deficit occurs when a country imports more goods and services than it exports. A trade surplus is the opposite. The current account surplus or deficit includes not only goods and services but also net income from abroad and net current transfers. A capital account surplus represents net inflow of capital.
What is the main purpose of hedging foreign exchange risk for a company?
- To profit from expected currency fluctuations.
- To eliminate uncertainty and stabilize future costs and revenues.
- To increase the company's overall profit margin.
- To speculate on the movement of exchange rates.
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Answer: B. To eliminate uncertainty and stabilize future costs and revenues.
Hedging is a strategy used by companies to protect themselves against adverse movements in exchange rates. Its primary goal is to reduce or eliminate the uncertainty associated with future currency fluctuations, thereby stabilizing costs, revenues, and the value of international transactions.
What is a major risk associated with a country maintaining a fixed exchange rate for an extended period?
- Lack of monetary policy independence to manage the domestic economy.
- Excessive currency appreciation that harms exports.
- Constant need to increase foreign exchange reserves.
- Reduced foreign investment due to exchange rate volatility.
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Answer: A. Lack of monetary policy independence to manage the domestic economy.
To maintain a fixed exchange rate, a country's monetary policy (particularly interest rates) often needs to be aligned with that of the country whose currency it is pegged to, or to be used for direct market intervention. This severely limits the central bank's ability to use monetary policy tools to address domestic economic issues like inflation or unemployment.