How can central banks defend their currency—for example, if the currency is within a target zone or pegged at a particular value?

What will be an ideal response?

The monetary authorities in the countries with weaker currencies have three basic defense mechanisms available: interventions, interest rate increases, and capital controls. Interventions (see Questions 7 and 9) to support the local currency may result (when not sterilized) in a lower money supply, reduced liquidity in the money market, and therefore higher interest rates. Central banks can also directly raise the interest rates they control (typically, the rate at which banks can borrow from the central bank), both to make currency speculation more costly and to signal commitment to the central rate. Finally, the authorities can limit foreign exchange transactions through capital controls, which may include taxes on (or outright prohibition of) the purchases of most foreign securities by the country's residents.