Question

Foreign currency exchange rate risk can be hedged in

Answer 1

Dear Student

The foreign exchange rate is determined by the free market forces of demand and supply of foreign exchange.

Therefore any change in the demand and supply of foreign exchange would lead to a change in the foreign exchange rate as well. 

Foreign exchange is demanded by domestic residents for the following reasons:

Purchasing goods and services from foreign countries

Purchasing financial securities/assets in foreign countries

For sending gifts abroad

To invest directly in shops, factories, buildings, etc. in foreign countries.

To speculate on the value of foreign currencies

To undertake foreign tours

To make payments for international trade.​

The demand curve is downward sloping, indicating an inverse relationship between the price of foreign exchange and its quantity demanded, i.e., more of foreign exchange is demanded at a lower price and vice-versa

Supply of foreign exchange comes from foreigners who make payment in foreign exchange for various purposes like:

Purchase of home country’s (India) goods and services through exports.

Investment in home country’s (India) bonds and equity shares

Sending of savings by home country’s (Indian) workers working abroad to their families in India.

Touring the home country.

The supply curve is upward sloping, indicating a direct relationship between the price of foreign exchange and its quantity supplied, i.e., more of foreign exchange is supplied at a higher price and vice-versa.

Hope this information clarifies your doubts. Keep posting :-)
Regards