Question

The exchange rate of currency is maintained at the same level in all the foreign exchange markets through _____________.

• A. exchange arbitrage
• B. interest arbitage
• C. hedging
• D. speculation

Answer 1

The correct option is A exchange arbitrage

Arbitrage refers to the simultaneous buying or selling of foreign currencies with the intention of making profits from the differences between the exchange rates prevailing in different markets at the same time. The one who conducts arbitrage trade is known as an arbitrageur. Exchange arbitrage leads to change in demand and supply of currencies, so as to bring in a balance in exchange rates in all the markets.
For example, if $1 = Rs.10 in India and $1 = Rs.12 in Nepal. The arbitrageur in this case will buy dollars in India at Rs. 10 and sell it for Rs. 12 in Nepal. Thus, the demand rise in India will lead to rise in exchange rate in India, while, increased supply in Nepal will lead to fall in exchange rate in that market, leading to elimination of difference in exchange rates between both the markets.