Reason Based & Extra Questions -Foreign Exchange Rate | Crash Course of Macro Economics -Class 12 - Commerce PDF Download

Reason Based Question’s

(Q1) If foreign exchange reserves of India are on rise,  it mean growth of economy

Ans: False , not necessarily, in case of India, it is certainly not out foreign reserves have tended to rise largely because of remittances from abroad by the NRIs.

(Q2) Giving reasons, state which of the following statements is true or false :

(a)Faced with an adverse balance of payments, the government should drastically devalue rupee.

(b) Portfolio investment by foreigners in our country is a very lucrative source of foreign capital inflow.

(c) Domestic growth suffers when MNCs invest in our country

(d) Trade surplus and current account deficits may coexist.

(e) Depreciation of a currency encourages exports while it discourages imports 

(f) Depreciation of a currency has the same effect on exports as devaluation of currency.

Ans:

(a) False , This will  not only destabilize the domestic economy but will also adversely affect the external sector.

(b) False , Volume maybe high but its permanence is questionable

(c) False , MNCs contribute to income generation.

(d) True ,  Trade surplus is obtained when the value of exports of a country during a year exceeds the value of imports of goods during that year.  Current account is calculated by summing up the trade account and the account of invisibles.

(e) True 

(f) True ,   however the term ‘depreciation’ is used when the currency is on a free float.  The term ‘devaluation’ is used when the currency is on a fixed exchange rate system.

(Q3) Greater flow of foreign exchange from rest of the world always indicates higher level of development of the domestic economy.

Ans: False. Because greater flow of foreign exchange may be occurring on account of borrowings from rest of the world.

(Q4) Fixed exchange rate system requires huge reserve of gold while flexible exchange rate does not.
Ans: True. Fixed exchange rate system is always supported with huge reserve of gold. Because, foreign currencies are convertible into gold.

(Q5) 
(a) Float rate of exchange refers to flexible rate of exchange.
Ans: T

(b) In a situation of excess demand, equilibrium exchange rate is automatically restored.
Ans: T

(c) Equilibrium exchange rate rises when supply of foreign currency increases in the    international money market.
Ans: F

(d) Export of goods and services from India to US would mean outflow of foreign exchange to India.
Ans: F

(e) Appreciation of foreign currency induces lower foreign direct investment from ret of the world.
Ans: F

(f) In order to restore the value of depreciating domestic currency, central bank buys the US dollars in the international money market.
Ans: F

(g) The rising demand for foreign goods implies higher demand for foreign exchange.

EXTRA QUESTION’S  

(Q1) “ RBI intervenes to control depreciation of the rupees.” Why ?  Give two reasons.

Ans: (a) The cost of imported goods in terms of rupee goes up.  All intermediate goods begin to cost more.  As a result, prices of final goods go up & hence Inflation happens

(b) The rupee value of India’s external debt goes up.  This poses problems for the country’s Balance of Payments.

(Q2)  “ Slump in global oil prices ” 

(a) How will it affect India ?
(b) What will be the adverse consequences ?

Ans: (a)  India is a big importer of crude oil.  A fall in oil prices means India will save a large amount of dollars.  This will improve the CAD.

(b) UAE is a big importer of Indian goods.  With fall in oil prices, the revenue earned by USE will fall.  As a result, demand for India goods will suffer.

(Q3)  “ Government approves 100% FDI in medical devices. ”

(a) Why this relaxation in FDI rules ? (b) How is domestic industry affected by this ?

Ans: (a) The proposal to relax the policy has been mooted by the commerce and industry ministry.  Since medical devices fell under the pharmaceutical category so far, they were subjected to FDI limits and other conditions such as mandatory government permission

(b) Currently, India imports at least 70% of medical devices used in the country.  As part of the ‘Make in India’ campaign, the government has relaxed the policy, hoping to attract investments and boost domestic manufacturing.  Local manufacturers are concerned about the misuse of the relaxation in FDI rules.

(Q4)  A big rise in the Foreign Exchange Rate (FER) adversely affects the imports in the country.  How can this rise be managed and by whom in the interest of social welfare ?

Ans: This rise in the FER is the floating rate and the central bank tries to influence the rate by “entering” the market as bulk buyer/seller.  

 When it finds this floating rate to be too high, its starts selling FE from its resources to bring down the rate , in order to help the importers especially of items like rare life saving medicines etc. in the interest of social welfare.  This adjustment in the floating rate of exchange is known as managed floating rate.

(Q5) ‘ A rise in BPO Services in the economy can be considered a good source of supply of foreign currency.  Justify.

Ans: This has been mainly due to the cheaper cost with reasonable degree of skill and efficiency of labour.  There is a good inflow of supply of foreign exchange, from the economy point of view which in turn proves beneficial for it.

(Q6)  Assume that the market price of US dollar was increased considerably leading to rise in price of the imports of essential goods.  What can central bank do to ease the situation?

Ans: The Central Bank can increase the supply of foreign exchange from its reserves in order to decrease the value of dollar.

(Q7) Explain the impact of the recent devaluation of Chinese Yuan on India’s Balance of Trade.

Ans: The  imports of Chinese goods by India will now increase.  This is because Chinese goods will now become cheaper 

(Q8) If British pound becomes costlier in terms of domestic currency, is it good or bad for growth of Indian economy?  Give reasons.            , or 

If US doller becomes costlier in terms of the Indian rupee, it is good as well as bad for the domestic growth. How ?

Ans: It is good in one aspect because purchasing power of British pound in Indian market will increase.  Britishers will increase imports from India leading to rise in India’s exports which is beneficial for Indian economy. 

 At the same time it is bad also because imports of capital goods from UK will become expensive.

(Q9) How does giving incentives for exports influence foreign exchange rate?  Explain.

Ans: Export incentives lead to increase in export of goods and services which in turn increase inflow of foreign exchange.  Demand for the foreign exchange remaining unchanged, increase in supply of foreign exchange leads to decrease in rate (that is Currency Appreciation)

(Q10)  A British company has ordered readymade garments from an Indian company.  What will be the impact on their total import expenditure if foreign exchange rate increases?

Ans: It will reduce the total import expenditure of British company because increase in the foreign exchange rate (here British pound) will raise the purchasing power of the company.  It means that same amount of goods can be purchased from India with lesser amount of British pounds implying fall in total import expenditure. But if Ed > 1  , then more willbe demanded leading to rise in their import expenditure 

(Q11) Increase in interest rate in the domestic economy leads to an appreciation of domestic currency.  Your comments?

Ans: If domestic interest rises (say in India) and is higher than the interest rate in rest of the world, the foreigners will be induced to shift their funds to the Indian economy.  Increase in supply of foreign exchange leads to decrease in exchange rate (that is Currency Appreciation)

(Q12) How are NRI deposits significant for us?

Ans: Also, constant supply of foreign exchange (by way of NRI deposits) keeps the exchange rate under check.  This facilitates the import of essential goods like crude oil
(Q13) State any two factors that explain extension of demand for a foreign currency in response to a fall in its price.

Ans: (i) When foreign currency (say US $) becomes cheaper (that is currency appreciation) , less domestic currency is to be paid for one unit of dollar . Accordingly, imports become lucrative/cheaper . This raises demand for foreign currency.

(ii) When foreign currency becomes cheaper, domestic investors will be induced to make greater investment in rest of the world. Accordingly, demand for foreign currency rises

(Q14) Why is flexible rate of exchange called free rate of exchange?

Ans: Flexible rate of exchange is called free rate of exchange, as it is freely determined by the forces of supply and demand in the international money market.

(Q15) Would you always justify depreciation of the Indian currency as it leads to a rise in exports or , Will you always appreciate a rise in exchange rate as a means to boost our exports ?

Ans: No. Because a rise in exchange rate ( currency depreciation) may not always lead to a rise in our export earnings. A rise in exchange rate is beneficial only when elasticity of demand for our exports is greater than unity.

(Q16) Recently, the government of India launched the ‘Incredible India’ campaign to promote tourism in India. How will this affect the price of foreign exchange?

Ans: With the launch of the ‘Incredible India’ campaign, foreign tourists will be encouraged to visit India. As more and more foreigners visit India, the supply of foreign exchange will also increase resulting in decrease in the price of foreign exchange (or rate of exchange) . In other words there would be Currency Appreciation 

(Q17) What impact will fall on the expenditure of American citizen who comes to India if foreign exchange rate of Indian currency appreciates.

Ans: American citizen will get less domestic currency for one unit of dollar for the payment of his medical treatment. His expenditure will increase on this treatment. 

(Q18) Recently, the rate of dollars has shot up and the Indian rupee has become very weak against dollars. What does this indicate ? Use a numerical example. Also explain its effect on the economy and balance of trade of the country. How will the RBI control this situation ? 

Ans: When Indian rupee becomes weaker against US dollers, then it is known as domestic currency depreciation. For example, 1$ = Rs. 60 to  1$ = Rs. 65. This shows domestic currency depreciation i.e. now an Indian has to pay more rupees in order to buy 1$.

Currency depreciation has two major effects:

(a) It will lead to an increase in exports because domestic goods are now cheaper.

(b) It will also lead to a decrease in imports because foreign goods are now costlier.

So, the balance of trade will be on a surplus side since exports are increasing and imports are decreasing. As far as the RBI is concerned, in order to reduce this high foreign exchange rate, it will increase the supply of foreign exchange by selling the foreign exchange from its reserves so as to bring down its value [ Managed Floating ]

(Q19) Suppose the foreign exchange rate changed from 1$ = Rs. 50 to 1$ = Rs. 60. Do you think it is necessary that central bank should intervene to control the foreign exchange rate ?

Ans: Yes, to safeguard the interest of the importers. The Central Bank can start selling dollars from its ‘reserves’ to control the foreign exchange rate. 

(Q20) If India’s currency is appreciated, then what will be its impact on exports of the country ?

Ans: exports will fall. 

(Q21) Why does demand for foreign exchange arise for speculative activities ?

Ans: Demand for foreign exchange arises when people want to speculate on the value of foreign currency . Speculators demand foreign currency in the present period with the aim of selling it in future at higher prices. For example, Manish purchases 1,000 US$ at Rs. 50 per dollar with the expectation of selling the dollars at higher prices.

(Q22) During the economic reforms of 1991, India devalued its currency. Why does a country devalue its own currency ?

Ans: In 1991, foreign exchange reserves fell to the lowest level and it led to the foreign exchange crisis in the country. Therefore, India devalued its currency in 1991 to increase the inflow of foreign exchange reserve.

(Q23) We are importing too much from China. Is it good for our economy ? Explain.

Ans: No

(Q24) How does decrease in FDI in india act as a supply shock of forign exchange  ?

Ans:  Supply decreases , Exchange rate rises , currency depreciation

(Q25) If inflation is higher in country A than in Country B, and the exchange rate between the two countries is fixed, what is likely to happen to the trade balance between the two countries ?

Ans: In this situation, the exports from country B to country A will rise and it will lead to surplus trade balance for country B. However, due to higher prices in country A, its imports will increase from country B and it will lead to deficit in trade balance for country.

(Q26) Equilibrium exchange rate in the foreign exchange market is often unfavourable to less developed countries. Why ?

Ans: This is because a less developed country like India depends on developed countries like USA for the import of plant and machinery (and related technology) for its development programmes. This causes a situation of adverse or negative balance of payments for the less developed countries. Accordingly, their forex reserves are low while the need for such reserves (to cope with rising imports) continues to be high. Paying more and more for a dollar in the international market) is Leads to high exchange rate..

(Q27) M/S. Mohan  Chand and Sons Pvt. Ltd. receive a bank advice intimating that a sum of $ 1 billion has been received from UAE Brothers, Muscat, against imports of books by them. How will it affect India’s rupee ?

Ans: Supply of dollars will increase. Price of dollars will fall. Rupee will appreciate. 

(Q28) M/S Reliance Petroleum advises its banker HBSC Bank to remit $ 2 billion dollars to Gulf Oil Co. Dubai, towards settlement of their bill. How will it affect the exchange value of Indian rupee

(Q29) If inflation is higher in India than in the USA and the fixed exchange rate system is followed, what is likely to happen to the trade balance between the two countries?

(Q30)  Value of US $ on the rise for last few months.  Discuss its likely impact on the imports of India.

(Q31) ‘ The recent depreciation of rupee has its roots into huge Current Account Deficit ’.  Defend or refute the statement.

‘Higher imports are the prime reason for the current macroeconomic crisis faced by India’.  Do you agree?  Give valid reasons for your point of view.

(Q32). ‘ Law of demand applies to foreign exchange as well’.  Do you agree?  State valid reasons in support of your answer.

(Q33)“ Floating Exchange Rate System is always better than the Fixed Exchange Rate System ”.  Do you agree?  Give valid arguments in favour of your answer.

(Q34) How is the rising demand for the Indian goods in the US market likely to impact the exchange rate between the Indian rupee and US dollar?

(Q35) Exchange rate of US$ rose considerably in India. Explain the impact of this on Indian exports and analyse its repercussion on the general masses.

(Q36) ‘India has adopted the policy of managed float rate’. Comment.

(Q37) If there is a big increase in India’s imports from abroad, can it influence the exchange value of Indian rupee ? Explain.

(Q38) How does giving incentives for exports influence foreign exchange rate ? Explain.

(Q39) If the demand of US dollars in India increases but supply of US dollars remains constant, what will be the effect on exchange rate for USA dollars ?

(Q40) Would the central need to intervene in a managed floating system ? Explain

(Q41) Is improvement in exchange rate always beneficial ?

(Q42) ‘ Foreign exchange rate in a country (say India) is on the rise’.  What impact it is likely to have on exports and imports of the country?  Explain.