Currency Markets

• A. A physical market where only tourists exchange cash
• B. A global decentralized market where currencies are bought and sold ✓
• C. A stock exchange that lists only foreign company shares
• D. A government agency that sets fixed national currency values

Why: The foreign exchange market is a global, decentralized (over-the-counter) market where participants trade one currency for another, operating 24 hours a day across major financial centers.

• A. US dollar
• B. Euro ✓
• C. Both are base currencies
• D. Neither; pairs have no base currency

Why: In a currency pair, the first currency listed is the base currency. Here the euro (EUR) is the base, and the US dollar (USD) is the quote currency. The price shows how many USD are needed to buy one EUR.

• A. The euro has weakened against the dollar
• B. The euro has strengthened against the dollar ✓
• C. The dollar has strengthened against the euro only
• D. Nothing; exchange rates do not change

Why: A rise in EUR/USD from 1.10 to 1.20 means one euro now buys more US dollars, so the euro has appreciated (strengthened) relative to the dollar.

• A. A type of bank fee charged on every transaction
• B. The smallest standard price movement in a currency pair, usually 0.0001 ✓
• C. A government-issued currency coin
• D. The total daily volume traded in a market

Why: A pip (percentage in point) is the standard unit of price movement for most currency pairs, typically the fourth decimal place (0.0001). For yen pairs, it is usually the second decimal place (0.01).

• A. The time difference between two trading sessions
• B. The difference between the bid price and the ask price ✓
• C. The total amount of currency held by a bank
• D. The interest rate paid on a currency deposit

Why: The spread is the gap between the bid price (what buyers will pay to buy from you, i.e., the price you receive when selling) and the ask price (what sellers want when you buy). It is a primary way brokers and market makers earn revenue.

• A. US Dollar (USD)
• B. Euro (EUR) ✓
• C. Both currencies share equal weight
• D. Neither; the pair is quoted in gold

Why: In a currency pair, the first currency listed is the base currency. In EUR/USD, the euro is the base and the US dollar is the quote currency. The price shows how many units of the quote currency are needed to buy one unit of the base currency.

• A. 1 USD equals 1.10 EUR
• B. 1 EUR equals 1.10 USD ✓
• C. 1 EUR equals 1.10 cents
• D. The euro is worth 10% less than the dollar

Why: The quote 1.1000 means one euro (the base currency) costs 1.10 US dollars (the quote currency). The number always tells you how much of the quote currency is needed for one unit of the base currency.

• A. USD/TRY
• B. USD/JPY ✓
• C. USD/ZAR
• D. USD/THB

Why: USD/JPY is a major pair because both the US dollar and the Japanese yen are among the most heavily traded currencies in the world. Pairs like USD/TRY, USD/ZAR and USD/THB involve emerging-market currencies and are classified as exotic or minor pairs.

• A. The price at which the dealer will buy the base currency from you ✓
• B. The price at which the dealer will sell the base currency to you
• C. The average of the buy and sell prices
• D. The fee charged for executing a trade

Why: The bid is the price at which the dealer or market maker is willing to buy the base currency from you, so it is the price you receive when selling. The ask (or offer) is the price at which they sell to you, which is always higher than the bid.

• A. The commission charged by a broker
• B. The smallest standard price movement in a currency pair, usually 0.0001 for most pairs ✓
• C. The total spread between two currencies
• D. A type of margin requirement

Why: A pip, or percentage in point, is the standard unit of price movement in forex. For most pairs it is the fourth decimal place (0.0001). For pairs involving the Japanese yen, a pip is usually the second decimal place (0.01).

• A. A decrease in domestic interest rates
• B. An increase in domestic interest rates ✓
• C. A rise in domestic inflation relative to trading partners
• D. A sustained trade deficit with the rest of the world

Why: Higher domestic interest rates attract foreign capital seeking higher returns, increasing demand for the domestic currency and causing it to appreciate. The other options tend to weaken the currency.

• A. 1 USD = 5 MXN ✓
• B. 1 USD = 0.2 MXN
• C. 1 USD = 500 MXN
• D. 1 USD = 100 MXN

Why: PPP holds that the exchange rate equates the price of identical goods across countries. Dividing the Mexican price by the US price (500/100) gives 5 pesos per dollar.

• A. The relative money supply growth of two countries ✓
• B. The daily speculation of currency traders
• C. Central bank intervention in a single day
• D. Tourist spending in the domestic economy

Why: The monetary approach links exchange rates to relative money supplies and money demand. Countries with faster money supply growth tend to see their currencies depreciate over the long run.

• A. The yen tends to appreciate against the euro ✓
• B. The yen tends to depreciate against the euro
• C. The exchange rate remains unchanged permanently
• D. The euro necessarily depreciates against all currencies

Why: Higher productivity lowers production costs and boosts export competitiveness and real returns, increasing demand for the more productive country's currency. The Balassa-Samuelson effect supports this appreciation.

• A. The central bank holds large foreign exchange reserves and credible policy
• B. Investors expect the fixed exchange rate peg to be abandoned due to weak fundamentals ✓
• C. The country has a current account surplus and low inflation
• D. Interest rates are stable and inflation is near target

Why: Speculative attacks occur when markets doubt a peg can be sustained, often due to weak fundamentals such as large deficits or reserve depletion. Traders then sell the currency in anticipation of devaluation.

• A. An agreement to exchange currencies at a rate fixed today for delivery at a specified future date
• B. An exchange of currencies for delivery typically within two business days of the trade date ✓
• C. A contract that gives the holder the right, but not the obligation, to exchange currencies at a set rate
• D. An exchange of currencies that is settled only at the end of the calendar year

Why: A spot transaction is the immediate exchange of currencies, with settlement usually occurring within two business days (T+2) of the trade date. Forward agreements, by contrast, settle at a future date.

• A. The central bank's target exchange rate for the currency
• B. The average spot rate over the past year
• C. The spot rate adjusted for the interest rate differential between the two currencies ✓
• D. The expected future spot rate set by government forecasters

Why: Under covered interest rate parity, the forward rate equals the spot rate adjusted for the interest rate differential between the two currencies over the contract period. This prevents risk-free arbitrage.

• A. A discount
• B. Par
• C. A premium ✓
• D. Parity with the spot rate

Why: When the forward rate is higher than the spot rate for the base currency, the base currency trades at a forward premium. This typically occurs when the base currency has a lower interest rate than the quote currency.

• A. A spot purchase of euros
• B. A forward contract to sell US dollars for euros at the 90-day rate ✓
• C. A forward contract to buy US dollars for euros at the 90-day rate
• D. A spot sale of US dollars

Why: The company will receive dollars and needs euros or its home currency, so it should sell dollars forward for euros at the agreed 90-day rate. This locks in the exchange rate and removes uncertainty about the future spot rate.

• A. Same day (T+0)
• B. Next business day (T+1)
• C. Two business days after the trade date (T+2) ✓
• D. Thirty days after the trade date

Why: Most major currency pairs settle on a T+2 basis, meaning the exchange of currencies occurs two business days after the trade date. Some pairs, such as USD/CAD, settle on T+1, but T+2 is the standard convention.

• A. A standardized contract traded on an exchange to buy or sell currency at a future date at a price set today
• B. A private agreement to exchange a specified amount of one currency for another at a fixed rate on a future date ✓
• C. An option giving the holder the right, but not the obligation, to exchange currencies at a later date
• D. A loan denominated in foreign currency with interest paid in the domestic currency

Why: A currency forward is an over-the-counter (OTC) agreement between two parties to exchange currencies at a predetermined rate on a set future date. Exchange-traded standardized contracts are futures, not forwards, and options give a right rather than an obligation.

• A. Futures are customized private contracts, while forwards are standardized and exchange-traded
• B. Futures are standardized and exchange-traded with daily settlement, while forwards are customized OTC contracts settled at maturity ✓
• C. Futures always require physical delivery of currency, while forwards are always cash-settled
• D. Futures have no counterparty risk, while forwards have no margin requirements

Why: Currency futures are standardized in size and maturity, traded on exchanges, and marked to market daily through a clearinghouse. Forwards are tailored between two parties and typically settle only at maturity, carrying more counterparty risk.

• A. Buy euros forward
• B. Sell euros forward ✓
• C. Borrow euros today
• D. Buy euro call options only as a speculative bet on a stronger euro

Why: The company is long euros and will receive them in the future, so it faces the risk that the euro falls in value. Selling euros forward locks in a dollar exchange rate for those euros, eliminating the downside risk.

• A. The obligation to buy or sell a currency at a set price on a future date
• B. The right, but not the obligation, to buy or sell a currency at a specified strike price before or on expiry ✓
• C. Ownership of the foreign currency deposit with guaranteed interest
• D. A guaranteed exchange rate that the seller must honor only if the buyer pays a premium at expiry

Why: An option grants the holder a right, not an obligation. A call gives the right to buy the currency and a put gives the right to sell it, at the strike price. The buyer pays an upfront premium for this flexibility.

• A. To eliminate all interest rate exposure for both parties
• B. To allow each party to obtain financing in a currency they could otherwise borrow in only at a higher cost ✓
• C. Because regulations require principal exchange in all derivative contracts
• D. To guarantee that exchange rates remain fixed for the contract's entire life

Why: A currency swap lets two parties swap debt obligations in different currencies. Exchanging principal at inception and maturity allows each party to access funding in a foreign currency, often at better terms than borrowing directly in that market.

• A. To maximize corporate profits in the banking sector
• B. To maintain price stability, often by targeting a low and stable inflation rate ✓
• C. To set exchange rates at a fixed level against gold
• D. To finance government spending directly through unlimited loans

Why: Most central banks, such as the Federal Reserve (with its dual mandate) and the European Central Bank, prioritize price stability, typically targeting around 2% inflation. This anchors expectations and supports sustainable economic growth.

• A. The price of gold in international markets
• B. Short-term borrowing costs across the economy, including interbank lending rates ✓
• C. The number of tourists visiting the country
• D. The minimum wage set by the government

Why: The policy rate, such as the federal funds rate or the ECB's main refinancing rate, anchors short-term money market rates. Changes ripple through to bank lending rates, mortgages, and business loans, affecting spending and inflation.

• A. Raising taxes to reduce the money supply
• B. A central bank purchasing large quantities of government bonds or other assets to inject liquidity and lower long-term interest rates ✓
• C. Selling foreign currency reserves to strengthen the domestic currency
• D. Requiring commercial banks to hold higher reserves

Why: QE involves large-scale asset purchases by the central bank, which increases the money supply and pushes down long-term yields. It is typically used when short-term policy rates are already near zero and further stimulus is needed.

• A. It depreciates because higher rates signal economic weakness
• B. It appreciates because higher returns attract foreign capital seeking yield ✓
• C. It remains unchanged because exchange rates are unaffected by interest rates
• D. It becomes pegged to gold automatically

Why: Higher domestic interest rates make assets denominated in that currency more attractive to foreign investors seeking returns, increasing demand for the currency and causing it to appreciate, all else being equal. This is the interest rate parity mechanism.

• A. A法 requirement that banks disclose their future lending plans to regulators
• B. Central bank communication about the likely future path of policy, used to shape market expectations ✓
• C. A forecasting model that predicts exchange rates one year ahead
• D. A tax incentive for businesses that invest in future projects

Why: Forward guidance is the central bank's communication about its intended future policy path. By influencing expectations about future interest rates, it can affect current long-term rates and financial conditions even before any actual policy change occurs.

• A. The risk that a currency's value changes between the time a contract is agreed and when it is settled ✓
• B. The risk that a bank fails while holding foreign currency deposits
• C. The risk that exchange rates move against a company's overall long-term market value
• D. The risk that government controls prevent the conversion of currency at all

Why: Transaction risk arises from the time lag between agreeing a foreign-currency payment or receipt and actually settling it, during which the exchange rate can move and change the home-currency value of the cash flow.

• A. A forward contract
• B. A currency swap
• C. A currency option ✓
• D. A spot transaction

Why: A currency option grants the buyer the right to buy or sell a currency at a fixed strike rate on or before a certain date, without obligating them to exercise it. Forwards and swaps create binding obligations.

• A. Buy euros forward
• B. Sell euros forward ✓
• C. Borrow euros today
• D. Buy U.S. dollars forward

Why: The company will receive euros and needs to convert them to dollars. Selling euros forward locks in the dollar amount it will get, protecting it if the euro weakens against the dollar.

• A. Using only spot market transactions to avoid derivatives
• B. Matching foreign-currency revenues with foreign-currency costs so that exposures offset ✓
• C. Hedging with contracts that are settled automatically by the central bank
• D. Keeping all cash in the home currency to avoid any exposure

Why: A natural hedge reduces exposure without derivatives by aligning currency inflows and outflows, such as a firm that earns and spends in the same foreign currency, so gains and losses offset.

• A. Its foreign-currency revenue converts into fewer domestic currency units, reducing its home-currency income ✓
• B. Its foreign-currency revenue converts into more domestic currency units, increasing its home-currency income
• C. There is no effect because exporters are not exposed to exchange rates
• D. Its costs rise by the same proportion as its revenues, leaving profit unchanged

Why: When the home currency appreciates, each unit of foreign currency buys fewer home-currency units. An exporter paid in foreign currency therefore receives less in home-currency terms, hurting its margins.