Meaning and types of foreign exchange rates (fixed, pegged, flexible, hybrid) | International Economics Notes

Waseem Shaikh May 20, 2025

Meaning of Foreign Exchange Rate

A foreign exchange rate (or forex rate) is the value of one country’s currency expressed in terms of another country’s currency. In simple terms, it is the price at which one currency can be exchanged for another156. For example, if the USD/INR rate is 83, one US dollar can be exchanged for 83 Indian rupees. Exchange rates play a crucial role in international trade, investment, tourism, and the overall economic health of a country16.

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Types of Foreign Exchange Rates

Foreign exchange rate systems can be broadly categorized into four main types: fixed, pegged, flexible (floating), and hybrid (managed float).

1. Fixed Exchange Rate

Definition:
A fixed exchange rate is a system where the value of a currency is set and maintained by a country’s government or central bank at a specific rate relative to another currency (such as the US dollar) or a basket of currencies2456.

How it works:
The central authority intervenes in the foreign exchange market, buying or selling its own currency to maintain the fixed rate.

Examples:
The Hong Kong dollar and the Saudi Arabian riyal are pegged to the US dollar2.

Advantages:
Provides stability and predictability in international transactions, helps control inflation.

Disadvantages:
Limits monetary policy flexibility, may lead to trade imbalances or currency crises if the fixed rate becomes unsustainable4.

2. Pegged Exchange Rate

Definition:
A pegged exchange rate is a type of fixed rate where a currency’s value is “pegged” to another major currency or a basket of currencies, but with some flexibility to adjust within a certain band or range23.

How it works:
The central bank maintains the peg by intervening in the market, but may allow the currency to fluctuate within a narrow band (for example, ±1% of the pegged rate)3.

Examples:
Argentina and Venezuela have used pegged or fixed parity arrangements in the past3.

Advantages/Disadvantages:
Similar to fixed rates, but with slightly more flexibility to respond to market pressures.

3. Flexible (Floating) Exchange Rate

Definition:
A flexible or floating exchange rate is determined by the forces of supply and demand in the foreign exchange market, without direct government or central bank intervention12456.

How it works:
Currency values fluctuate freely based on market conditions, economic indicators, interest rates, and investor sentiment.

Examples:
The US dollar, euro, and British pound all operate under floating exchange rates2.

Advantages:
Allows automatic adjustment to economic conditions, corrects trade imbalances, and provides monetary policy independence.

Disadvantages:
Can lead to volatility and uncertainty in international transactions4.

4. Hybrid (Managed Float or Dirty Float) Exchange Rate

Definition:
A hybrid or managed floating exchange rate combines elements of both fixed and floating systems. The currency’s value is mostly determined by market forces, but the central bank may occasionally intervene to stabilize or guide the rate127.

How it works:
Governments or central banks buy or sell currencies to prevent excessive fluctuations or to achieve economic objectives.

Examples:
China, Singapore, and Vietnam use managed float systems2.

Advantages:
Offers a balance between flexibility and stability, allowing countries to respond to both market conditions and policy goals.

Disadvantages:
Requires active management and can sometimes lack transparency.

Summary Table

TypeDetermination MethodExample CountriesKey Features
FixedSet by government/central bankHong Kong, Saudi ArabiaStability, low flexibility
PeggedSet to another currency, with bandsArgentina, VenezuelaFixed with limited fluctuation
FlexibleMarket supply and demandUS, Eurozone, UKHigh flexibility, market-driven
HybridMarket-driven + occasional interventionChina, Singapore, VietnamMix of stability and flexibility

This detailed explanation covers the meaning and the main types of foreign exchange rates-fixed, pegged, flexible, and hybrid-along with their mechanisms and examples.

Top 20 MCQs on the meaning and types of foreign exchange rates (fixed, pegged, flexible, hybrid)

  1. The price of one currency in terms of another currency is called:
    a) Interest rate
    b) Foreign exchange rate
    c) Balance of payment
    d) Trade rate
    Answer: b) Foreign exchange rate4
  2. A system where the value of a currency is set and maintained by the government or central bank is called:
    a) Flexible exchange rate
    b) Fixed exchange rate
    c) Pegged exchange rate
    d) Hybrid exchange rate
    Answer: b) Fixed exchange rate24
  3. In a flexible exchange rate system, the exchange rate is determined by:
    a) Central bank
    b) Government
    c) Market forces of demand and supply
    d) International Monetary Fund
    Answer: c) Market forces of demand and supply24
  4. A pegged exchange rate system means:
    a) Currency value is allowed to float freely
    b) Currency value is fixed to another currency with some flexibility
    c) Currency value is determined by gold
    d) None of the above
    Answer: b) Currency value is fixed to another currency with some flexibility
  5. A managed floating (hybrid) exchange rate system is also known as:
    a) Clean float
    b) Dirty float
    c) Fixed rate
    d) Pegged rate
    Answer: b) Dirty float4
  6. Which of the following is an example of a country with a fixed exchange rate?
    a) United States
    b) Hong Kong
    c) United Kingdom
    d) Japan
    Answer: b) Hong Kong
  7. When the value of domestic currency falls due to market forces, it is called:
    a) Appreciation
    b) Depreciation
    c) Revaluation
    d) Devaluation
    Answer: b) Depreciation4
  8. When the value of domestic currency rises due to market forces, it is called:
    a) Appreciation
    b) Depreciation
    c) Devaluation
    d) None of the above
    Answer: a) Appreciation4
  9. Devaluation of currency occurs under:
    a) Flexible exchange rate system
    b) Fixed exchange rate system
    c) Managed floating system
    d) None of the above
    Answer: b) Fixed exchange rate system4
  10. Revaluation of currency occurs under:
    a) Flexible exchange rate system
    b) Fixed exchange rate system
    c) Managed floating system
    d) None of the above
    Answer: b) Fixed exchange rate system4
  11. Depreciation of currency occurs under:
    a) Fixed exchange rate system
    b) Flexible exchange rate system
    c) Managed floating system
    d) None of the above
    Answer: b) Flexible exchange rate system4
  12. Appreciation of currency occurs under:
    a) Fixed exchange rate system
    b) Flexible exchange rate system
    c) Managed floating system
    d) None of the above
    Answer: b) Flexible exchange rate system4
  13. Under which system does the central bank intervene to prevent excessive fluctuations in exchange rates?
    a) Fixed exchange rate
    b) Flexible exchange rate
    c) Managed floating (hybrid) exchange rate
    d) All of the above
    Answer: c) Managed floating (hybrid) exchange rate4
  14. If the US dollar exchanges for Rs. 40 instead of Rs. 50 earlier, the Indian rupee has:
    a) Depreciated
    b) Appreciated
    c) Devalued
    d) None of these
    Answer: b) Appreciated2
  15. An increase in the value of the domestic currency leads to:
    a) Increase in exports
    b) Decrease in exports
    c) No effect on exports
    d) None of the above
    Answer: b) Decrease in exports4
  16. A decrease in the value of the domestic currency leads to:
    a) Increase in imports
    b) Decrease in imports
    c) Increase in exports
    d) Both b and c
    Answer: d) Both b and c4
  17. Which exchange rate system allows for both appreciation and depreciation?
    a) Fixed exchange rate
    b) Flexible exchange rate
    c) Managed floating exchange rate
    d) None of the above
    Answer: b) Flexible exchange rate4
  18. A hybrid exchange rate system is characterized by:
    a) No government intervention
    b) Only fixed rates
    c) Market-determined rates with occasional intervention
    d) Pegging to gold
    Answer: c) Market-determined rates with occasional intervention
  19. Which of the following best describes a pegged exchange rate?
    a) Fixed to a single currency or basket with a narrow band
    b) Allowed to float freely
    c) Determined by gold reserves
    d) None of the above
    Answer: a) Fixed to a single currency or basket with a narrow band
  20. Under a fixed exchange rate system, if the government lowers the value of its currency, it is called:
    a) Appreciation
    b) Depreciation
    c) Devaluation
    d) Revaluation
    Answer: c) Devaluation4

These MCQs cover the essential concepts and distinctions among fixed, pegged, flexible, and hybrid exchange rate systems, as well as related terminology and effects246.

References:

  1. https://www.shareindia.com/knowledge-center/currency-trading/foreign-exchange-rate
  2. https://www.westernunion.com/blog/en/us/3-kinds-of-exchange-rates-explained/
  3. https://www.investopedia.com/articles/forex/12/a-primer-on-currency-regimes.asp
  4. https://byjus.com/commerce/difference-between-fixed-and-flexible-exchange-rate/
  5. https://byjus.com/commerce/foreign-exchange-rate/
  6. https://www.investopedia.com/terms/e/exchangerate.asp
  7. https://www.nextias.com/blog/exchange-rate/
  8. https://www.fisdom.com/what-is-foreign-exchange-rate/
  9. https://en.wikipedia.org/wiki/Exchange_rate_regime
  10. https://socialsci.libretexts.org/Bookshelves/Economics/Economics_(Boundless)/32:_Open_Economy_Macroeconomics/32.2:_Exchange_Rates
  11. https://www.investopedia.com/trading/floating-rate-vs-fixed-rate/
  12. https://www.westernunion.com/blog/en/us/how-currency-exchange-rates-work/
  13. https://www.imf.org/external/np/mfd/er/2004/eng/0604.htm
  14. https://testbook.com/ugc-net-economics/exchange-rate
  15. https://en.wikipedia.org/wiki/Exchange_rate
  16. https://corporatefinanceinstitute.com/resources/economics/exchange-rate/
  17. https://testbook.com/ugc-net-commerce/foreign-exchange-rate
  18. https://nios.ac.in/media/documents/318courseE/L-34%20FOREIGN%20EXCHANGER%20RATE.pdf
  19. https://testbook.com/objective-questions/mcq-on-foreign-exchange-market--5fc4296995a9708a21c5d136
  20. https://www.scribd.com/document/758928776/Ch-18-MCQ-EXCHANGE-RATE
  21. https://sde.uoc.ac.in/sites/default/files/sde_videos/MCQ-Foreign%20Exchange%20Management.pdf
  22. https://commerceaspirant.com/mcq-on-foreign-exchange-rate-class-12/
  23. https://testbook.com/objective-questions/mcq-on-external-sector-and-currency-exchange-rate--5eea6a1239140f30f369ec5b
  24. https://study.com/academy/practice/quiz-worksheet-fixed-floating-exchange-rates.html
  25. https://websites.umich.edu/~alandear/courses/340/studyquestions/S13a-ER.pdf
  26. https://www.studocu.com/en-gb/document/the-london-school-of-economics-and-political-science/finance/mcq-answers-5-fx-market/4023620
  27. https://www.scribd.com/document/393358779/1-MCQS-ON-Forex-Management
Waseem Shaikh

Posted by Waseem Shaikh

Hello, I had done my graduation in psychology and economics and currently doing post graduation in economics. I make articles on economics and psychology related contents.

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