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IAI Actuarial Core Principles · Business Economics · Balance of payments and exchange rates

Under a pure free-floating exchange rate regime, what determines the value of the domestic currency?

Under a pure free float the currency's value is set by supply and demand in the foreign exchange market, with no official intervention. Regimes where the central bank defends a target, peg or band involve official rate management and therefore are not free floats.

  1. AThe central bank's announced target rate, defended by intervention
  2. BSupply and demand for the currency in the foreign exchange market, with no official interventionCorrect
  3. CA fixed peg to a basket of trading partners' currencies
  4. DThe government's gold reserves held against notes issued
  5. A crawling band that is adjusted monthly by the finance ministry

Explanation

In a pure float the rate is set by market supply and demand for the currency, and the central bank does not intervene. Pegs, baskets, gold backing and crawling bands all involve official determination or defence of the rate, so they describe other regimes.

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