Final answer:
A country can fix its currency to another by the central bank either buying domestic currency or selling foreign currency, and vice versa, to maintain a stable exchange rate. However, central banks need to be cautious about their reserve levels and potential inflation.
Step-by-step explanation:
For a country to fix its currency to another currency and assure a stable exchange rate, several mechanisms can be employed. These methods include intervention by a country's central bank in foreign exchange markets to maintain the currency's value. The options given in the question are mechanisms by which a central bank manipulates the currency's value:
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- a. Buying domestic currency or selling foreign currency to assure a stable exchange rate.
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- c. Selling domestic currency or buying foreign currency to assure a stable exchange rate.
These actions could take the form of direct intervention in the foreign exchange markets or indirect intervention via financial instruments such as government bonds. Central banks can increase or decrease the supply of their currency in foreign exchange markets to target a certain exchange rate relative to another currency. For a currency to fall, a central bank can supply more of its domestic currency, while for a currency to rise, a central bank should buy back its currency, using reserves of international currencies like the U.S. dollar or the euro.