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Question
Briefly discuss the fixed exchange rate system of determining foreign exchange rate.
Solution
In a fixed exchange rate system, the Central Bank sets the official exchange rate. Such an exchange rate remains constant regardless of changes in foreign currency demand and supply. To keep the currency exchange rate stable, the Central Bank purchases foreign currency when the rate rises and sells it when the rate falls. This procedure is also known as pegging; hence, the fixed exchange rate system is sometimes referred to as the pegged exchange rate system.
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