ACCA Financial Management (F9) Certification Practice Exam

What is a fixed exchange rate?

1. An exchange rate that fluctuates freely

2. An exchange rate set by market demand

3. An exchange rate maintained at a specific value by the government

4. An exchange rate that is dependent on inflation rates

The correct answer is: An exchange rate maintained at a specific value by the government

A fixed exchange rate is defined as an exchange rate that is maintained at a specific value by the government or central bank. This means that the value of the currency is tied to another major currency or a basket of currencies. The government intervenes in the foreign exchange market to stabilize the currency value, buying and selling the currency as needed to maintain the desired exchange rate target. This system creates predictability and stability in international pricing and transactions, which can be beneficial for trade and investment. By keeping the exchange rate constant, it reduces the risks associated with currency fluctuations, helping businesses plan their financial operations more effectively. In contrast, other choices describe different exchange rate mechanisms, such as flexible exchange rates which are determined by market forces without direct government intervention, or rates influenced by broader economic factors like inflation. However, a fixed exchange rate specifically emphasizes the government's role in maintaining a stable currency value.