FIA Global Financial Markets 4 — Questions and Answers
Question 1: In global derivatives markets, what is the difference between an 'exchange-traded' and an 'OTC' derivative?
- Exchange-traded derivatives are standardized and cleared centrally; OTC derivatives are customized bilateral contracts (Correct answer)
- OTC derivatives must be reported to stock exchanges before trading
- Exchange-traded derivatives always carry higher counterparty risk than OTC
- OTC derivatives are only available to retail investors
Correct answer: Exchange-traded derivatives are standardized and cleared centrally; OTC derivatives are customized bilateral contracts
Exchange-traded derivatives use standardized contracts with central clearing, reducing counterparty risk, while OTC derivatives are privately negotiated with terms tailored between parties.
Question 2: Which of the following best describes 'quantitative easing' (QE) as a monetary policy tool?
- A central bank purchases large-scale assets to inject liquidity when interest rates are near zero (Correct answer)
- A government increases taxation to reduce inflation
- A central bank raises reserve requirements for commercial banks
- A government issues new currency to pay off sovereign debt
Correct answer: A central bank purchases large-scale assets to inject liquidity when interest rates are near zero
QE involves a central bank buying financial assets (typically government bonds) to increase money supply and lower long-term interest rates when conventional rate cuts are exhausted.
Question 3: What is the function of a central counterparty (CCP) in financial markets?
- It interposes itself between buyer and seller, guaranteeing settlement and reducing counterparty risk (Correct answer)
- It sets the official interest rate for interbank lending
- It regulates the listing requirements for new securities
- It manages sovereign wealth fund investments
Correct answer: It interposes itself between buyer and seller, guaranteeing settlement and reducing counterparty risk
A CCP becomes the buyer to every seller and seller to every buyer, mutualizing and managing counterparty risk through margin requirements and default funds.
Question 4: Which indicator is most commonly used to measure overall stock market performance in the United States?
- S&P 500 Index (Correct answer)
- Dow Jones Transportation Average
- Russell Microcap Index
- Wilshire 5000 Equal-Weighted Index
Correct answer: S&P 500 Index
The S&P 500, comprising 500 large-cap US companies weighted by market capitalization, is the most widely referenced benchmark for US equity market performance.
Question 5: What does 'sovereign risk' mean in the context of global bond markets?
- The risk that a national government will default on its debt obligations (Correct answer)
- The risk that a corporation's bonds are downgraded by a rating agency
- The risk of currency fluctuation eroding bond returns
- The risk that central banks will raise interest rates unexpectedly
Correct answer: The risk that a national government will default on its debt obligations
Sovereign risk is the probability that a government will fail to honor its debt repayments, as seen in defaults by Argentina, Greece, and others.
Question 6: In international trade finance, what is a 'letter of credit' (LC)?
- A bank guarantee that a buyer's payment to a seller will be received on time and for the correct amount (Correct answer)
- A government permit allowing imports above a specified tariff quota
- A credit rating issued by an international agency for an exporting firm
- A multilateral agreement reducing trade barriers between member nations
Correct answer: A bank guarantee that a buyer's payment to a seller will be received on time and for the correct amount
A letter of credit is a bank-issued document guaranteeing a seller will receive payment from a buyer once specified conditions (e.g., shipping documents) are met.
Question 7: Which of the following best describes the concept of 'financial contagion'?
- The spread of financial distress from one market or institution to others through direct or indirect linkages (Correct answer)
- The deliberate export of inflation from one country to its trading partners
- The synchronized rise of asset prices across multiple countries
- The adoption of a common currency by multiple nations
Correct answer: The spread of financial distress from one market or institution to others through direct or indirect linkages
Financial contagion occurs when a shock in one market or country rapidly transmits to others, as seen when the US subprime crisis spread globally in 2007–2008.
FIA Global Financial Markets 4
In global derivatives markets, what is the difference between an 'exchange-traded' and an 'OTC' derivative?