ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The uncertainties ensuing from exchange-rate fluctuations for the foreign trade can easily lead to a contraction of the trade of the developing countries. The exporters and importers run all the greater risks because the developing countries have no functioning forward exchange markets.

Detailed explanation-2: -Also, countries are more insulated from problems of foreign countries under a freely floating exchange rate system. However, a disadvantage of freely floating exchange rates is that firms have to manage their exposure to exchange rate risk.

Detailed explanation-3: -Floating exchange rates are prone to fluctuations and are highly volatile by nature. A currency value against another currency may deteriorate only in one trading day. Furthermore, the short-term volatility in a floating exchange rate cannot be explained through macroeconomic fundamentals.

Detailed explanation-4: -Answer and Explanation: The given statement is True. The floating interest rate or exchange rate is determined by markets. It depends upon the market demand and supply which adds uncertainty to trade.

Detailed explanation-5: -In the goods market, a positive shock to the exchange rate of the domestic currency (an unexpected appreciation) will make exports more expensive and imports less expensive. As a result, the competition from foreign markets will decrease the demand for domestic products, decreasing domestic output and price.