The document discusses foreign exchange rates, distinguishing between fixed and flexible exchange rates. Fixed exchange rates provide stability and attract foreign capital but require large gold reserves and can lead to balance of payments issues. Flexible exchange rates are determined by supply and demand, allowing for automatic adjustments, but they introduce uncertainty and can discourage investment.

1. Foreign
Exchange Rate

3. Foreign Exchange Rate
Fixed Exchange Rate Flexible Exchange Rate

4. Fixed Exchange Rate
It is the rate which officially fixed in
terms of gold or any other currency
by the govt . It doesn’t vary with the
changes in demand and supply of
foreign currency .

5. Merits of fixed exchange rate
1. It ensures stability in Exchange Rate
•The exporters and importers do not have to operate under uncertainty about
the exchange rate.
• It promotes foreign trade .
2. Promotes capital movements
Fixed exchange rate system attracts foreign capital because a stable currency
doesn’t involve any uncertainties about exchange rate that may cause capital
loss.
3.Fixed exchange rate prevents outflow of capital assets
Fixed exchange rate prevents outflow of gold or other capital assets to the
rest of the world ,occurring due to uncertainties of exchange rate .
4.Prevents speculation in foreign exchange market.
It prevents speculation in foreign exchange market . Accordingly hedging is not
required.

6. Demerits
•Huge reserves of gold
Fixed exchange rate system requires huge reserves of gold . This is
because different currencies are directly or indirectly convertible
into gold .
•Deficits in BoP and surplus in BoP.
If the fixed exchange rate is at a level which is lower than the
market level ,it ll result in deficit in BoP . I f it is higher than the
market level ,it will result in surplus in BoP. There will be
undervaluation or overvaluation of currency .
• Equilibrium rate
Since exchange rate is fixed by govt , supply and demand forces
are not allowed to operate. So fixed exchange rate may not be in
the equilibrium rate , allocation of resources may not be optimum or
efficient.

7. Flexible Exchange Rate
It is the rate which is
determined by the forces of
demand and supply.

8. Merits of Flexible Exchange Rate
• Automatic adjustment in BoP.
It eliminates the problem of undervaluation
and over valuation of currencies, deficit or
surplus in BoP is automatically corrected.
•Frees the govt from the problem of BoP
•There is no need for the govt to hold any
foreign exchange reserves.

9. Demerits
•Uncertainty and confusion .
Flexible exchange rate presents an atmosphere of
uncertainty and confusion .
•Hampering Investment:
Unregulated free-floating exchange rate often
discourages foreign investment as exchange rate
becomes erratic
•Risk /instability and speculation
Flexible exchange rate encourages wide speculation
since foreign exchange prices are not known in
advance as in fixed exchange rate.