FIA Foreign Exchange & Currency Markets Flashcards

What is the 'carry trade' strategy in foreign exchange?

Answer: Borrowing in a low-interest-rate currency and investing in a high-interest-rate currency

The carry trade involves borrowing a low-yielding currency and investing the proceeds in a higher-yielding currency to profit from the interest rate differential.

Which exchange rate regime allows the currency's value to be determined entirely by market supply and demand?

Answer: Free float (clean float)

A free float (or clean float) regime allows the currency's value to fluctuate freely based on market forces without government or central bank intervention.

What is the primary purpose of a currency option in risk management?

Answer: To provide the right, but not the obligation, to exchange currency at a set rate

A currency option grants the holder the right, but not the obligation, to exchange a set amount of currency at a predetermined rate, providing flexible downside protection.

Which of the following is a characteristic of the interbank foreign exchange market?

Answer: It is a decentralized over-the-counter market operating 24 hours a day

The interbank FX market is a decentralized over-the-counter market where banks trade currencies directly with each other around the clock across global time zones.

What does a country's 'current account deficit' indicate about its currency trade flows?

Answer: The country imports more goods and services than it exports

A current account deficit means a country imports more goods and services than it exports, resulting in more foreign currency leaving the country than entering.

Which term describes the risk that a counterparty in an FX transaction will fail to deliver the agreed currency?

Answer: Settlement risk (Herstatt risk)

Settlement risk, also called Herstatt risk, is the risk that one party delivers the currency it sold but the counterparty fails to deliver the currency it owes.