With reference to "Speculation" in the foreign exchange market, consider the following statements: 1. If investors expect a foreign currency to appreciate, they will demand more of it in the present. 2. Expectations of currency appreciation have no impact on the actual exchange rate. 3. Speculation can destabilize the exchange rate by amplifying market forces. Which of the statements given above is/are correct?

The correct option is 1 and 3 only. Explanation Speculation in the foreign exchange market involves trading currencies with the primary objective of making a profit from expected future fluctuations in exchange rates. It relies heavily on market expectations regarding the future value of a currency. Statement-wise Analysis: - Statement 1 is Correct: If market participants expect a foreign currency to appreciate (increase in value) in the future, they will attempt to purchase it in the present to sell it later at a higher price. This profit motive drives an increase in the current demand for that currency. - Statement 2 is Incorrect: Expectations of appreciation directly impact the actual exchange rate. As investors demand more of the currency in the present (anticipating future gains), the demand curve for that currency shifts to the right. Consequently, the exchange rate rises immediately, causing the currency to appreciate in the present. This phenomenon is often referred to as a self-fulfilling prophecy. - Statement 3 is Correct: Speculation can amplify market trends and lead to volatility. If a large number of speculators bet against a currency, it can lead to a sharp depreciation or appreciation that may not align with the country's economic fundamentals, thereby destabilizing the exchange rate mechanism. Key Takeaway: In a floating exchange rate system, current exchange rates are significantly influenced by expectations of future values. An expectation of appreciation increases current demand, leading to immediate actual appreciation.

NCERT Class 12 Economics — Chapter 8: Open Economy Macroeconomics

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With reference to "Speculation" in the foreign exchange market, consider the following statements:

If investors expect a foreign currency to appreciate, they will demand more of it in the present.
Expectations of currency appreciation have no impact on the actual exchange rate.
Speculation can destabilize the exchange rate by amplifying market forces.

Which of the statements given above is/are correct?

Official previous-year question

Verified 1 Aug 2026.

Options

A1 and 2 only
B1 and 3 only
C1, 2 and 3
D2 only

Did you get this right?

Solution

The correct option is 1 and 3 only.

Explanation

Speculation in the foreign exchange market involves trading currencies with the primary objective of making a profit from expected future fluctuations in exchange rates. It relies heavily on market expectations regarding the future value of a currency.

Statement-wise Analysis:

Statement 1 is Correct: If market participants expect a foreign currency to appreciate (increase in value) in the future, they will attempt to purchase it in the present to sell it later at a higher price. This profit motive drives an increase in the current demand for that currency.
Statement 2 is Incorrect: Expectations of appreciation directly impact the actual exchange rate. As investors demand more of the currency in the present (anticipating future gains), the demand curve for that currency shifts to the right. Consequently, the exchange rate rises immediately, causing the currency to appreciate in the present. This phenomenon is often referred to as a self-fulfilling prophecy.
Statement 3 is Correct: Speculation can amplify market trends and lead to volatility. If a large number of speculators bet against a currency, it can lead to a sharp depreciation or appreciation that may not align with the country's economic fundamentals, thereby destabilizing the exchange rate mechanism.

Key Takeaway:
In a floating exchange rate system, current exchange rates are significantly influenced by expectations of future values. An expectation of appreciation increases current demand, leading to immediate actual appreciation.

Your note

More from Chapter 8: Open Economy Macroeconomics

In a fixed exchange rate system, if there is an excess supply of foreign currency, the Central Bank must:

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Which one of the following is considered a primary advantage of a flexible exchange rate system?

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Consider the following statements regarding the "Demand for Domestic Goods" vs "Domestic Demand for Goods": 1. In a closed economy, they are the same. 2. In an open economy, domestic demand for goods excludes imports. 3. In an open economy, the demand for domestic goods excludes exports. Which of the statements given above is/are correct?

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Consider the following statements regarding the linkages in an open economy: 1. In an output market linkage, an economy can trade in goods and services with other countries, widening consumer choice. 2. In a financial market linkage, investors are restricted to choosing only between domestic assets. 3. Movement of goods has traditionally been seen as a substitute for the movement of labour between countries. Which of the statements given above is/are correct?

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Consider the following statements regarding the Balance of Payments (BoP): 1. It records only the transactions involving the government sector with the rest of the world. 2. It typically records transactions for a specified time period, usually a year. 3. The Reserve Bank of India currently publishes data according to the new classification of three accounts: current, financial, and capital. Which of the statements given above is/are correct?

hard

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The correct option is 1 and 3 only.

Explanation

Statement-wise Analysis:

Statement 1 is Correct: If market participants expect a foreign currency to appreciate (increase in value) in the future, they will attempt to purchase it in the present to sell it later at a higher price. This profit motive drives an increase in the current demand for that currency.
Statement 2 is Incorrect: Expectations of appreciation directly impact the actual exchange rate. As investors demand more of the currency in the present (anticipating future gains), the demand curve for that currency shifts to the right. Consequently, the exchange rate rises immediately, causing the currency to appreciate in the present. This phenomenon is often referred to as a self-fulfilling prophecy.
Statement 3 is Correct: Speculation can amplify market trends and lead to volatility. If a large number of speculators bet against a currency, it can lead to a sharp depreciation or appreciation that may not align with the country's economic fundamentals, thereby destabilizing the exchange rate mechanism.