The foreign exchange market is the market in which national currencies are traded for one another. Currencies have to be exchanged because there is no single currency used all over the world. Suppose a company in the United States buys cheese from France. The French seller must be paid in euros, so the U.S. importer first exchanges U.S. dollars for euros. Travel works in the same way. A French tourist in Egypt cannot pay in euros to see the pyramids, because the euro is not the currency used there. The tourist has to exchange euros for Egyptian pounds at the current exchange rate.
In the passage, the U.S. importer exchanges U.S. dollars for euros. In the U.S. foreign exchange market, this adds to:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → the demand for foreign exchange, since euros are needed to buy goods from abroad
For the U.S., euros are foreign exchange. The importer needs euros to pay for goods bought from abroad, so he adds to the demand for foreign exchange.
Supply of foreign exchange would come from foreigners buying U.S. goods or assets. Giving up dollars does not raise the demand for dollars; it supplies them.
NCERT (2026-27): “Demand for Foreign Exchange People demand foreign exchange because: they want to purchase goods and services from other countries; they want to send gifts abroad; and, they want to purchase financial assets of a certain country. …” “Supply of Foreign Exchange Foreign currency flows into the home country due to the following reasons: exports by a country lead to the purchase of its domestic goods and services by the foreigners; foreigners send gifts or make transfers; and, the assets of a home country are bought by the foreigners. …” |