In a flexible exchange rate system, the exchange rate is determined by the interaction of demand and supply of foreign exchange. An increase in imports increases the demand for foreign currency, causing the demand curve for foreign exchange to shift rightward (Step 3). As demand exceeds supply at the initial rate, the market establishes a new equilibrium exchange rate at a higher level (Step 4), such as from ₹50/$ to ₹70/$. This means the domestic currency depreciates (Step 1), since more rupees are now required to buy one dollar. Consequently, the cost of purchasing foreign goods in rupees increases (Step 2). Thus, the correct sequence is 3 → 4 → 1 → 2.

Under a completely flexible exchange rate system, the exchange rate is determined entirely by the demand and supply of foreign exchange. The government or central bank does not continuously intervene to maintain any particular exchange rate. Therefore, the Assertion is false because maintaining large foreign exchange reserves is unnecessary in a purely flexible exchange rate system. The Reason is also false because constant intervention by the central bank is a feature of fixed or managed exchange rate systems, not a completely flexible system. Hence, both Assertion and Reason are false.

The exchange rate increases from ₹50 per dollar to ₹70 per dollar. Percentage increase: [ \frac{\text{New Rate} - \text{Old Rate}}{\text{Old Rate}} \times 100 \frac{70-50}{50}\times100 \frac{20}{50}\times100 40% ] Thus, the price of one dollar in rupees increases by 40%. Therefore, the correct answer is D. 40%.

In a flexible exchange rate system: 1. Shift from ₹50/$ to ₹70/$ represents an increase in the exchange rate, i.e., an upward shift in the exchange rate (c). 2. Shift from ₹70/$ to ₹50/$ represents a decrease in the exchange rate, i.e., a downward shift in the exchange rate (d). 3. Price of foreign currency rises means more rupees are needed to buy one unit of foreign currency, indicating depreciation of the domestic currency (a). 4. Value of the domestic currency relative to the dollar rises means the domestic currency appreciates (b). Thus, the correct matching is 1-c, 2-d, 3-a, 4-b.

The investor purchases 1000 pounds at ₹80 per pound, investing: 1000 × 80 = ₹80,000 If the exchange rate rises to ₹85 per pound, the value of the investment becomes: 1000 × 85 = ₹85,000 Profit: ₹85,000 − ₹80,000 = ₹5,000 Percentage profit: [ \frac{5000}{80000}\times100=6.25% ] Hence, the expected percentage profit is 6.25%.

The Assertion is true because expectations of future appreciation encourage investors and speculators to buy foreign currency immediately. This raises the present demand for that currency, pushing up its current exchange rate. Such expectations become self-fulfilling, as the anticipated appreciation occurs due to increased present demand. The Reason is false because speculators do not wait until the end of the month. They purchase the currency immediately to benefit from the expected future increase in its value. Their immediate actions create market pressure and influence the exchange rate today. Therefore, Assertion is true and Reason is false.

Interest rate differentials influence exchange rates because investors seek higher returns by purchasing financial assets in countries offering higher interest rates. This process requires free movement of capital. If investors face restrictions in purchasing foreign government bonds or other financial assets, they cannot shift funds internationally even if interest rates are attractive. Option C is correct because unrestricted access to foreign financial markets is the essential assumption behind interest rate-induced capital flows. Option A would discourage capital flows rather than facilitate them. Option B is unnecessary since interest rate movements affect capital flows even when inflation exists. Option D is unrelated because exchange rate determination through capital flows occurs under modern exchange rate systems and does not require the gold standard.

When Country B offers a higher interest rate than Country A, investors seek better returns by investing in Country B. Statement 1 is correct because investors in Country A buy Country B's currency to purchase financial assets. Statement 2 is correct because investors in Country B have less incentive to invest in Country A, reducing demand for Country A's currency. Statement 3 is correct because, from Country A's perspective, reduced capital outflows from abroad lower the demand for foreign currency. Statement 4 is correct because increased demand causes Country B's currency to appreciate while Country A's currency depreciates. Thus, all four statements together correctly describe the complete sequence.

The Assertion is false because higher domestic income does not guarantee depreciation of the domestic currency. Exchange rates are determined by several factors such as foreign income, exports, capital flows, interest rates, and exchange rate regime. The Reason is true because higher domestic income increases consumer purchasing power. A portion of this additional spending is directed toward imported goods, increasing demand for foreign exchange and tending to depreciate the domestic currency if other factors remain unchanged. Thus, the Reason is correct, but it does not justify the absolute claim made in the Assertion.

An increase in domestic income generally raises imports, increasing demand for foreign currency. An increase in foreign income generally raises exports, increasing demand for the domestic currency. Therefore, the final impact on the exchange rate depends on which effect is stronger. Option A is correct because the balance between export growth and import growth determines the overall pressure on the exchange rate. Option B is unrelated to this income-based mechanism. Option C does not directly determine exchange rate movements arising from income changes. Option D is incorrect because the WTO does not determine or fix exchange rate pegs.

The Assertion is true because the Purchasing Power Parity (PPP) theory states that, in the long run, exchange rates adjust according to differences in domestic and foreign price levels. The Reason is also true because PPP assumes free trade, negligible transportation costs, and the absence of trade barriers such as tariffs and quotas. Under these assumptions, the Law of One Price holds, implying that identical goods should have the same price across countries after adjusting for exchange rates. Therefore, differences in price levels eventually influence exchange rates. Hence, the Reason correctly explains the Assertion.

Using the NCERT formula: Real Exchange Rate = Nominal Exchange Rate × (Domestic Price Level / Foreign Price Level) Given: Nominal Exchange Rate = 1.25 yen per rupee Domestic Price Level (India) = 1.2 Foreign Price Level (Japan) = 3 Calculation: Real Exchange Rate = 1.25 × (1.2 / 3) = 1.25 × 0.4 = 0.5 Thus, the real exchange rate is 0.5.

The correct matching is: 1 → d: Setting e₁ > equilibrium e means increasing the exchange rate, which is devaluation. 2 → b: Setting e₂ < equilibrium e means reducing the exchange rate, which is revaluation. 3 → c: Purchasing dollars absorbs the excess supply of dollars. 4 → a: Selling previously accumulated dollars meets the excess demand for dollars. Therefore, Option C correctly matches all four elements.

The sequence begins with the government fixing the exchange rate below equilibrium. Step 2: Government fixes e₂ < e. Step 3: The lower exchange rate increases demand for dollars, creating excess demand. Step 4: The government/RBI supplies dollars from previously accumulated reserves. Step 1: If reserves cannot fully satisfy demand, a black market for dollars emerges. Thus, the correct order is 2 → 3 → 4 → 1.

Statement 1 is true because devaluation is an official government decision under a fixed exchange rate system. Statement 2 is true because devaluation increases the exchange rate (for example, from ₹50 per dollar to ₹70 per dollar). Statement 3 is false because devaluation makes the domestic currency cheaper, making domestic goods less expensive for foreigners and encouraging exports. Therefore, only Statements 1 and 2 are correct.

A shift from Rs 70 per dollar to Rs 50 per dollar means fewer rupees are required to buy one dollar. This indicates that the domestic currency has become stronger (costlier) relative to the foreign currency. In a fixed exchange rate system, such an official increase in the value of the domestic currency is called revaluation. Option B is correct because revaluation is a deliberate government action that lowers the exchange rate. Option A and Option C describe market-driven movements, not official policy actions. Option D is the opposite of revaluation.

Under a flexible exchange rate system, exchange rates are determined by market forces of demand and supply. Any Balance of Payments (BoP) deficit or surplus is automatically corrected through changes in the exchange rate. Since the central bank does not have to defend a fixed exchange rate continuously, it does not require large official foreign exchange reserves. Therefore, Option A is correct.

A fixed exchange rate system can be maintained only if the central bank has sufficient official foreign exchange reserves to buy or sell foreign currency whenever required. If reserves become inadequate, investors may expect the government to abandon the fixed rate, leading to speculative attacks and eventual devaluation. Therefore, Option B is correct.

The passage clearly states that "Without any formal international agreement, the world has moved on to what can be best described as a managed floating exchange rate system." This directly supports Option D. The other options contradict the passage because it neither mentions a UN mandate, a return to the gold standard, nor the Bretton Woods Agreement as the basis for the current managed floating system.

Under a managed floating (dirty floating) system, exchange rates are primarily determined by market forces. However, the central bank intervenes occasionally to reduce excessive fluctuations or stabilize the market. Unlike a fixed exchange rate regime, the central bank does not defend one permanently fixed exchange rate. Therefore, Option C correctly distinguishes managed floating from a purely fixed exchange rate system.