CPT Forex & Currency Markets 5

Question 1

What is the 'dollar smile' theory in forex markets?

Accepted Answer

The USD strengthens both during global growth booms and during risk-off crises, but weakens in moderate growth periods

Answer

The dollar smile theory, coined by Morgan Stanley, posits that the USD strengthens at both extremes—strong US growth and global risk-off flights to safety—but underperforms during steady global expansion.

Question 2

Which risk is unique to holding positions in emerging market (EM) currencies compared to G10 currencies?

Accepted Answer

Convertibility and capital control risk

Answer

EM currencies carry the added risk that a government may impose capital controls or restrict convertibility, preventing investors from repatriating funds or closing positions.

Question 3

How does the concept of 'sterilization' apply to central bank forex intervention?

Accepted Answer

The central bank offsets the domestic money supply impact of its FX purchases or sales using open market operations

Answer

Sterilized intervention means the central bank buys or sells FX while simultaneously conducting offsetting open market operations to neutralize the effect on domestic money supply.

Question 4

What does a persistent current account deficit typically imply for a country's currency over the long run?

Accepted Answer

It tends to put downward pressure on the currency as the country must finance the deficit with capital inflows

Answer

A chronic current account deficit means a country spends more on imports than it earns from exports, requiring sustained foreign capital inflows or reserve drawdowns that can weaken the currency long-term.

Question 5

In forex options, what does a 'risk reversal' position indicate when the implied volatility of puts exceeds that of calls for the same expiry?

Accepted Answer

The market has a net bearish bias on the base currency, with more demand for downside protection

Answer

A negative risk reversal (higher put implied vol than call) shows that market participants are paying a premium for downside protection, reflecting a bearish skew on the base currency.

(CPT) Certified Pro Trader Practice Test

(CPT) Certified Pro Trader Practice Test

CPT Forex & Currency Markets 5