Read the passage carefully and answer the questions based on the passage:

THE FOREIGN EXCHANGE MARKET

The market in which national currencies are traded with one another is known as the foreign exchange market. The major participants in the foreign exchange market are commercial banks, foreign exchange brokers and other authorized dealers and monetary authorities. It is important to note that although participants themselves may have their own trading centers, the market itself is world-wide. There is close and continuous contact between the trading centers and the participants deal in more than one market.

Foreign currency flows into the home country for the following reasons: exports by a country lead to the purchase of its domestic goods and services by foreigners; foreigners send gifts or make transfers; and, the assets of a home country are bought by foreigners. A rise in the price of foreign exchange will reduce foreigners' costs while purchasing products from India and other things will remain constant. This increases India's exports and hence the supply of foreign exchange may increase.

Different countries have different methods of determining their currency's exchange rate. It can be determined through Flexible Exchange Rate, Fixed Exchange Rate or Managed Floating Exchange Rate. Floating exchange rate is determined by the market forces of demand and supply. Where fixed exchange rate is determined by the government at a particular level. In floating exchange rate increasing value of currency is known as appreciation and a decreasing value is known as devaluation where in fix exchange rate decreased value is known as devaluation. Managed floating exchange rate is combination of flexible and fixed exchange rate where at certain movement central intervene through market operation to manage currency exchange rate. 

When income increases and due to increase in income the demand for foreign goods increases then in this scenario what impact does economy face on foreign exchange rate?

Depreciation of domestic currency.

The correct answer is Option (4) → Depreciation of domestic currency. 

When income increases, people’s purchasing power rises, and they tend to buy more foreign goods and services. To make these purchases, they need foreign currency, which leads to an increase in demand for foreign exchange. As the demand for foreign currency increases, its price (exchange rate) rises — meaning more domestic currency is required to buy the same amount of foreign currency. This results in a fall in the value of the domestic currency, known as depreciation.