Forex Trading Advanced Topics 2 — Questions and Answers
Question 1: What does the term 'carry trade' refer to in forex?
- Borrowing in a low-interest currency to invest in a high-interest currency (Correct answer)
- Trading currency futures on an exchange
- Holding a position overnight to avoid swap fees
- Using leverage to amplify intraday gains
Correct answer: Borrowing in a low-interest currency to invest in a high-interest currency
A carry trade involves borrowing in a low-yield currency and investing in a higher-yield currency to profit from the interest rate differential.
Question 2: Which risk most directly threatens a carry trade position?
- Spread widening
- Sharp reversal of the high-yield currency (Correct answer)
- Rising broker commissions
- Increased trading volume
Correct answer: Sharp reversal of the high-yield currency
A sudden depreciation of the high-yield currency can wipe out the accumulated interest income and produce large capital losses.
Question 3: In forex options, what does 'delta' measure?
- Time decay of the option premium
- Sensitivity of option price to a $1 move in the underlying (Correct answer)
- Implied volatility change
- Change in delta per unit change in the underlying
Correct answer: Sensitivity of option price to a $1 move in the underlying
Delta measures how much an option's price changes for each one-unit (one pip) move in the underlying currency pair.
Question 4: What is 'gamma' in the context of forex options?
- The rate of change of delta with respect to the underlying price (Correct answer)
- The sensitivity of an option to interest rate changes
- The annualized standard deviation of returns
- The time value remaining in an option
Correct answer: The rate of change of delta with respect to the underlying price
Gamma measures how quickly delta changes as the underlying price moves, indicating the curvature of the option's value.
Question 5: A trader opens a USD/CHF long position and simultaneously sells USD/JPY. This is an example of what strategy?
- Hedging correlated pairs
- A synthetic cross-rate trade (Correct answer)
- Statistical arbitrage
- A momentum breakout
Correct answer: A synthetic cross-rate trade
Trading two USD pairs in opposite directions effectively creates a synthetic CHF/JPY position without directly trading that cross.
Question 6: What is the primary purpose of a currency swap agreement between two central banks?
- To earn profit from interest rate differentials
- To provide emergency liquidity in a foreign currency (Correct answer)
- To speculate on exchange rate movements
- To eliminate trade imbalances
Correct answer: To provide emergency liquidity in a foreign currency
Central bank swap lines allow one central bank to provide its partner with foreign currency liquidity during financial stress.
Question 7: Which of the following best describes 'vega' in forex options trading?
- Sensitivity of option premium to changes in implied volatility (Correct answer)
- The rate at which time value decays
- The probability the option expires in the money
- The cost of delta-hedging the position
Correct answer: Sensitivity of option premium to changes in implied volatility
Vega measures how much an option's price changes for each 1% change in implied volatility.
Forex Trading Advanced Topics 2
What does the term 'carry trade' refer to in forex?