Analyzing Foreign Exchange Rate Statements

The question asks us to identify the statement that is incorrect regarding the Foreign Exchange Rate.

Understanding Different Exchange Rate Systems

Foreign exchange rate is the price of one currency in terms of another. Different countries use different systems to determine this rate. The main systems are Fixed Exchange Rate, Floating Exchange Rate, and Managed Floating Rate.

• Fixed Exchange Rate System: In this system, the government or central bank pegs the country's currency to another currency, a basket of currencies, or a commodity like gold. The government commits to buying or selling foreign currency to maintain the exchange rate at the fixed level.
• Floating Exchange Rate System: In this system, the exchange rate is determined by market forces, specifically the demand for and supply of currencies in the foreign exchange market. The government or central bank typically does not intervene to control the rate.
• Managed Floating Rate System: This system combines elements of both fixed and floating systems. The exchange rate is primarily determined by market forces, but the central bank may intervene occasionally to prevent excessive volatility or to steer the rate towards a desired range. This intervention is sometimes referred to as "dirty floating".

Evaluating Each Statement on Foreign Exchange Rate

Let's examine each given statement based on our understanding of these systems:

1. In case of Fixed Exchange Rate, exchange rate is fixed by the Government

   This statement aligns with the definition of a Fixed Exchange Rate system. The government or its central bank takes action to set and maintain a specific exchange rate.

   This statement appears to be correct.

2. Managed Floating rate is also called Dirty Floating

   As mentioned in the definition above, managed floating is indeed often referred to as "dirty floating" because the central bank intervenes in the market (gets its "hands dirty") to influence the exchange rate, even though it's largely market-determined.

   This statement appears to be correct.

3. Fixed Exchange rate system is also known as Floating Exchange rate system

   This statement is incorrect. Fixed and Floating exchange rate systems are two opposing methods of determining the exchange rate. A fixed system involves government control, while a floating system relies on market forces.

   This statement appears to be incorrect.

4. In case of Fixed Exchange rate system, some government action increases, the exchange rate

   In a fixed exchange rate system, the government intervenes to keep the rate at the target level. If market forces put downward pressure on the currency (causing it to depreciate below the target), the government would intervene, for example, by buying its own currency in the foreign exchange market. Buying its currency increases demand for it, which would cause the exchange rate to increase back towards the fixed target. Therefore, government action can indeed increase the exchange rate within a fixed system, specifically when it's depreciating.

   This statement appears to be correct in the context of government intervention to maintain the peg.

Conclusion: Identifying the Incorrect Statement

Based on the analysis of each statement, the statement that is incorrect with respect to the Foreign Exchange Rate is: "Fixed Exchange rate system is also known as Floating Exchange rate system". These are distinct systems.

Revision Table: Comparing Exchange Rate Systems

Additional Information: Key Foreign Exchange Concepts

Understanding additional terms related to foreign exchange rates is helpful:

• Appreciation: An increase in the value of a currency relative to another currency in a floating exchange rate system.
• Depreciation: A decrease in the value of a currency relative to another currency in a floating exchange rate system.
• Revaluation: An increase in the fixed value of a currency by government action in a fixed exchange rate system.
• Devaluation: A decrease in the fixed value of a currency by government action in a fixed exchange rate system.

In floating exchange rate systems, factors like interest rates, inflation, economic growth, political stability, and capital flows can significantly influence currency values.