Floating exchange rates are defined as

• A. A fixed rate system
• B. A system where exchange rates are free to fluctuate as a result of supply/demand of currency
• C. A currency backed by gold reserves
• D. A system where governments set exchange rates daily

Answer: (B)

The main idea is that floating exchange rates move because market forces set the price of currencies. In this system, the value of a currency rises or falls as demand for it and the supply of it in the foreign exchange market change. If investors want more of a country’s currency—perhaps due to higher interest rates, stronger growth, or positive sentiment—the currency appreciates. If there’s selling pressure—more supply, imports increasing, or risk concerns—the currency depreciates. Central banks may poke in from time to time, but they don’t fix the rate, so the rate isn’t anchored to a target or to something like gold, and governments don’t set a new rate every day. This distinguishes floating rates from fixed systems, gold-standard arrangements, or government-directed daily rates.