FIA Global Financial Markets 3 — Questions and Answers
Question 1: Which of the following best describes 'purchasing power parity' (PPP) as a theory of exchange rates?
- Exchange rates should adjust so that identical goods cost the same in different countries (Correct answer)
- Exchange rates are determined solely by interest rate differentials
- Governments set exchange rates to maximize export competitiveness
- Exchange rates reflect only speculative capital flows
Correct answer: Exchange rates should adjust so that identical goods cost the same in different countries
PPP theory states that exchange rates will adjust until the purchasing power of each currency is equalized, as reflected in the price of a common basket of goods.
Question 2: What is the primary role of a market maker in global financial markets?
- To continuously quote both buy and sell prices, providing liquidity (Correct answer)
- To execute trades only on behalf of retail investors
- To set regulatory limits on daily trading volumes
- To audit financial statements of listed companies
Correct answer: To continuously quote both buy and sell prices, providing liquidity
Market makers provide liquidity by continuously quoting bid and ask prices, standing ready to buy or sell securities at those prices.
Question 3: Which type of risk refers to the possibility that a counterparty in a financial transaction will default before settlement?
- Counterparty risk (Correct answer)
- Liquidity risk
- Systemic risk
- Currency risk
Correct answer: Counterparty risk
Counterparty risk is the danger that the other party in a financial contract will fail to fulfill its obligations prior to settlement.
Question 4: In global equity markets, what does 'ADR' stand for and what is its purpose?
- American Depositary Receipt — allowing US investors to buy shares in foreign companies in dollars (Correct answer)
- Adjusted Daily Return — measuring equity performance net of fees
- Automated Deal Routing — directing orders to the best-priced exchange
- Annual Dividend Report — disclosing a company's distribution history
Correct answer: American Depositary Receipt — allowing US investors to buy shares in foreign companies in dollars
An American Depositary Receipt (ADR) represents shares in a foreign company and trades on US exchanges in US dollars, simplifying foreign equity investment for American investors.
Question 5: What is the significance of LIBOR (London Interbank Offered Rate) in global financial markets, and what is replacing it?
- It was the benchmark rate for trillions in loans and derivatives; SOFR is replacing it in the US (Correct answer)
- It was the ECB's official policy rate; replaced by the Euro Short-Term Rate (€STR)
- It was the rate at which central banks lent to commercial banks; replaced by the Fed Funds Rate
- It was a credit rating benchmark; replaced by Bloomberg Indices
Correct answer: It was the benchmark rate for trillions in loans and derivatives; SOFR is replacing it in the US
LIBOR was the global benchmark for interbank lending rates underpinning hundreds of trillions in contracts; after manipulation scandals, SOFR became the primary US replacement.
Question 6: Which global financial crisis event in 2008 triggered widespread contagion across international markets?
- The collapse of Lehman Brothers, a major US investment bank (Correct answer)
- The bankruptcy of the Japanese government bond market
- The failure of the European Central Bank to set rates
- The simultaneous closure of all major stock exchanges
Correct answer: The collapse of Lehman Brothers, a major US investment bank
The September 2008 collapse of Lehman Brothers triggered a global credit freeze, stock market crashes, and a synchronized recession across most major economies.
Question 7: What does a 'yield curve inversion' signal to financial market participants?
- Short-term interest rates exceed long-term rates, often seen as a recession predictor (Correct answer)
- Central banks are expanding the money supply to stimulate growth
- Foreign demand for domestic bonds has surged, flattening returns
- Equity markets are overvalued relative to fixed income
Correct answer: Short-term interest rates exceed long-term rates, often seen as a recession predictor
An inverted yield curve, where short-term yields rise above long-term yields, has historically been a reliable leading indicator of economic recession.
FIA Global Financial Markets 3
Which of the following best describes 'purchasing power parity' (PPP) as a theory of exchange rates?