FIA FIA Foreign Exchange & Currency Markets 2 — Questions and Answers
Question 1: What is a forward exchange contract primarily used for?
- Speculating on short-term currency movements
- Hedging against future currency exchange rate risk (Correct answer)
- Exchanging currencies at today's spot rate
- Borrowing foreign currency from a central bank
Correct answer: Hedging against future currency exchange rate risk
A forward exchange contract locks in an exchange rate for a future date, allowing businesses to hedge against the risk of adverse currency movements.
Question 2: Which of the following best describes 'purchasing power parity' (PPP)?
- A theory stating exchange rates adjust so identical goods cost the same in different countries (Correct answer)
- A measure of a country's foreign currency reserves
- The ratio of exports to imports for a nation
- A central bank policy to stabilize exchange rates
Correct answer: A theory stating exchange rates adjust so identical goods cost the same in different countries
Purchasing power parity holds that exchange rates will adjust over time so that identical goods have equivalent prices across countries when expressed in a common currency.
Question 3: In the context of FX markets, what does 'pip' stand for?
- Percentage in point — the smallest standard price increment in a currency pair (Correct answer)
- Price index parameter — a measure of currency volatility
- Profit in position — the gain on an open currency trade
- Pound in parity — a reference to GBP exchange rates
Correct answer: Percentage in point — the smallest standard price increment in a currency pair
A pip (percentage in point) is the smallest standard price move in a currency pair, typically the fourth decimal place for most pairs.
Question 4: What is a 'currency swap'?
- An agreement to exchange principal and interest in one currency for those in another currency (Correct answer)
- The immediate exchange of two currencies at the current market rate
- A futures contract on a currency pair
- A government policy to replace one currency with another
Correct answer: An agreement to exchange principal and interest in one currency for those in another currency
A currency swap involves two parties exchanging principal and interest payments in different currencies over a specified period.
Question 5: Which factor does NOT typically cause a currency to depreciate?
- Higher inflation relative to trading partners
- A persistent current account deficit
- Rising interest rates relative to other countries (Correct answer)
- Loss of investor confidence in the economy
Correct answer: Rising interest rates relative to other countries
Rising interest rates typically attract foreign capital seeking higher returns, which causes a currency to appreciate rather than depreciate.
Question 6: What does 'triangular arbitrage' involve in the FX market?
- Exploiting price discrepancies among three currency pairs to earn a risk-free profit (Correct answer)
- Hedging exposure using three different forward contracts simultaneously
- Diversifying a portfolio across three major currency zones
- Calculating cross-rates using three central bank reference rates
Correct answer: Exploiting price discrepancies among three currency pairs to earn a risk-free profit
Triangular arbitrage involves converting one currency to a second, the second to a third, and the third back to the first to exploit inconsistencies in exchange rates.
FIA FIA Foreign Exchange & Currency Markets 2
What is a forward exchange contract primarily used for?