CPT Forex & Currency Markets 3 — Questions and Answers
Question 1: What does 'purchasing power parity' (PPP) theory suggest about long-run exchange rates?
- Exchange rates are determined solely by interest rate differentials
- Exchange rates adjust so that identical goods cost the same in different countries (Correct answer)
- Central banks maintain fixed exchange rates through PPP agreements
- Currency values are tied to gold reserves
Correct answer: Exchange rates adjust so that identical goods cost the same in different countries
PPP theory holds that exchange rates should eventually equalize the price of a basket of goods across countries, reflecting relative inflation differences.
Question 2: A trader is long USD/JPY. Which scenario would result in a profit?
- The Japanese yen strengthens against the dollar
- The US dollar weakens against the yen
- The US dollar appreciates against the yen (Correct answer)
- Interest rates in Japan rise sharply
Correct answer: The US dollar appreciates against the yen
Being long USD/JPY means buying USD and selling JPY; the position profits when the USD appreciates relative to the JPY.
Question 3: What is 'slippage' in forex trading?
- The gradual widening of the spread over time
- The difference between the expected execution price and the actual fill price (Correct answer)
- The daily rollover fee charged on open positions
- A penalty for trading outside market hours
Correct answer: The difference between the expected execution price and the actual fill price
Slippage occurs when an order is filled at a different price than requested, typically during fast-moving markets or low liquidity periods.
Question 4: Which economic indicator is most closely watched for its impact on the USD in forex markets?
- US Trade Balance
- US Non-Farm Payrolls (NFP) (Correct answer)
- US Housing Starts
- US Consumer Confidence Index
Correct answer: US Non-Farm Payrolls (NFP)
Non-Farm Payrolls, released monthly by the BLS, is the single most market-moving US economic release due to its implications for Fed monetary policy.
Question 5: What is the significance of a currency's 'reserve status'?
- It means the currency can only be traded by central banks
- Other countries hold it in large quantities to settle international trade and debt (Correct answer)
- The issuing country must back the currency with gold
- The currency is exempt from speculation and market manipulation
Correct answer: Other countries hold it in large quantities to settle international trade and debt
Reserve currencies are held by central banks worldwide for international transactions; the US dollar accounts for over 58% of global reserves.
Question 6: In the context of forex, what is 'rollover' (swap)?
- The process of converting profits from a foreign currency back to the account base currency
- The interest credit or debit applied when a position is held overnight (Correct answer)
- A strategy to roll losses forward into a future contract
- Closing and immediately reopening a position at the same price
Correct answer: The interest credit or debit applied when a position is held overnight
Rollover is the net interest (swap) paid or earned when a forex position is held past the daily settlement cutoff, based on the interest rate differential between the two currencies.
Question 7: Which statement about forex market liquidity is most accurate?
- Liquidity is uniformly high at all hours since forex is a 24-hour market
- Major pairs like EUR/USD are most liquid during the London–New York overlap (Correct answer)
- Exotic currency pairs typically have the tightest spreads
- Liquidity is highest during the Asian session for all pairs
Correct answer: Major pairs like EUR/USD are most liquid during the London–New York overlap
Even though forex trades 24 hours, liquidity peaks during the London–New York overlap, giving major pairs their tightest spreads and deepest order books at that time.
CPT Forex & Currency Markets 3
What does 'purchasing power parity' (PPP) theory suggest about long-run exchange rates?