Answer (A) is correct . In a freely floating exchange rate system, the government steps aside and allows exchange rates to be determined entirely by the market forces of supply and demand. The advantage of such a system is that it tends to automatically correct any disequilibrium in the balance of payments. The disadvantage is that a freely floating system makes a country vulnerable to economic conditions in other countries.
Answer (B) is incorrect because Forcing imports to be cheaper and exports more expensive can be accomplished with a fixed exchange rate system.
Answer (C) is incorrect because Freely floating exchange rates impose no constraints on the domestic economy.
Answer (D) is incorrect because A freely floating exchange rate system does not eliminate transaction risk (which must be hedged).
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