1. Vadim Sederko and Isabel Moray are trainees with Forex Global Partners. The company
actively participates in the interbank foreign exchange market and also trades with
individuals and corporate clients. Exhibit 1 shows the intermarket bid-offer spreads for
selected currency pairs:
Sederko and Moray then discuss aspects of interest rate parity:
Sederko:"For uncovered interest rate parity to hold, investors are assumed to be risk
neutral."
Moray:
"If uncovered interest rate parity holds, the current spot rate is the best predictor of
the future spot rate."
Sederko and Moray are discussing factors that may lead to changes in the bid-offer
spreads. Sederko offers the following as reasons why the JPY/USD spread would narrow:
Reason 1:"The JPY/USD spread will narrow when the Tokyo market is open, since the New
York and London markets will be closed and the yen is Japan's domestic
currency."
Reason 2:"For large orders where investors want to receive JPY in exchange for USD, the
spread will narrow since the large orders demonstrate a lot of demand for JPY."
Forex Global also trades in the forward currency markets. Thirty days ago, Sederko bought
USD 5 million in exchange for SGD with delivery in 90 days at the 90-day forward rate of
SGD/USD 1.3250–1.3350. He observes that today's SGD/USD spot rate is 1.3450–1.3650,
and that the forward points and risk-free rates for both currencies are as follows:
Question 1 of 6
Which of Sederko's reasons for why the JPY/USD bid-offer spread would narrow is correct?
a. Only Reason 1
b. Only Reason 2
c. Neither Reason 1 nor Reason 2
2. Question 2 of 6
Sederko learns that a competitor, Dealer X, is quoting MXN/EUR at the spot rate of
22.3000–23.3000. Based on Dealer X's quote and the information in Exhibit 1, could
Sederko realize an arbitrage profit in a transaction involving MXN and EUR?
a. No.
b. Yes, by buying EUR in the interbank market and selling EUR to Dealer X.
c. Yes, by buying EUR from Dealer X and selling EUR in the interbank market.
3. Question 3 of 6
Based on Exhibit 1, if Sederko entered into a transaction involving SGD and MXN and
wanted to be long SGD, which of the following MXN/SGD cross rates is most appropriate?
a. 34.4816
Sederko believes that covered interest rate parity exists between the USD and GBP. He
compiles the following information:
b. 36.0730
c. 37.6296
4. Question 4 of 6
Based on only the information in Exhibit 2, today's mark-to-market value (in SGD) of the
SGD/USD forward contract is closest to:
a. 56,527
b. 57,232
c. 57,289
7. Jerczy Walinski is a senior economist working for an international bank. He is responsible
for analyzing currency markets to support the bank's proprietary currency trading and the
advisory services provided to bank clients. Sonya Sanchez is a newly hired junior
economist assigned to assist Walinski.
Walinski asks Sanchez to assess the forward value of JPY compared with EUR using the
exchange rate and interest rate data presented in Exhibit 1.
5. Question 5 of 6
Based on Exhibit 3, the 90-day forward points for USD/GBP are closest to:
a. −9.44
b. 9.44
c. -37.58
6. Question 6 of 6
The two economists discuss the implications of the international parity relationships and
their use in forecasting future exchange rates. Walinski asks Sanchez to summarize the key
aspects of the international Fisher relationship. In response, Sanchez notes two important
implications of the international Fisher effect regarding the behavior of key economic
Which statement on interest rate parity is correct?
variables across countries:
a. Only Moray's statement
Implication 1:Real interest rates should converge on the same level.
b. Only Sederko's statement
Implication 2:Nominal interest rates should converge with expected inflation rates.
c. Neither Moray's statement nor Sederko's statement
Walinski then asks Sanchez to evaluate the usefulness of the interest rate parity
relationships regarding exchange rates. Sanchez makes two observations regarding
currency market participants' views on the theories:
Observation 1:Covered interest rate parity accurately describes the relationship of the spot
and forward exchange rates between two currencies and the interest rates in
those currencies. Its validity is proven by the arbitrage trading that occurs
anytime the spot/forward difference is inconsistent with interest rate
difference.
Observation 2:Uncovered interest rate parity does not accurately capture the relationship of
interest rate differences between currencies and expected changes in spot
exchange rates. This is borne out by the frequent use of carry trades to
earn higher returns by taking unhedged positions in high interest rate
currencies.
Walinski and Sanchez analyze the economic outlook for two countries and their currency
values relative to a global reserve currency. One of the countries is a large developed
market (DM), the other a small emerging market (EM). Both countries have recently begun
pursuing expansionary monetary policies to spur economic recoveries during a period of
stagnant growth following a recent global slowdown. Both countries are also raising taxes
and cutting government spending to prevent expansion of budget deficits. However,
Walinski notes that capital mobility and other economic policies differ between the countries:
DM has well-developed financial markets and places no restriction on foreign
ownership of domestic assets nor any restrictions on capital inflows or outflows. The
country's trade balance is usually at a small deficit relative to GDP. DM uses a freefloating-rate currency regime, its currency is fully convertible, and the central bank
generally does not intervene in currency markets.
EM has much less developed financial markets, places restrictions on foreign
9. Question 3 of 6
Which of the observations made by Sanchez regarding covered and uncovered interest rate
parity is (are) correct?
a. Observation 1 only
b. Observation 2 only
c. Both Observation 1 and Observation 2
10. Question 4 of 6
ownership of domestic assets, and restricts both inflows and outflows of capital. The
country usually has a sizeable trade surplus, though the size of the surplus has been
Based on the Mundell-Fleming model, relative to a global reserve currency, which
very sensitive to the exchange value of its currency. DM is both the largest market
currency(ies) will most likely depreciate?
for EM's exports and the largest source of its imports. Until recently, EM had a fixedexchange-rate regime, maintaining a specified parity to DM's currency. EM has
recently introduced a crawling peg intending to manage the value of its currency
relative to DM's in line with any difference in inflation between the two currencies.
DM is also considering easing restrictions on capital inflows to enable increased
foreign investment as a tool to spur domestic growth.
Walinski asks Sanchez to identify factors that may indicate an increased possibility of a
currency crisis for EM.
a. DM's currency only
b. EM's currency only
c. Both DM's currency and EM's currency
11. Question 5 of 6
If EM policymakers reduce the restrictions on capital inflows, which of the following could
become a disadvantage?
a. Appreciation of EM's currency
b. Increased foreign currency reserves
Question 1 of 6
Based on Exhibit 1, relative to EUR, JPY is most likely:
c. Increased foreign direct investment in EM
12. Question 6 of 6
a. trading at a forward premium.
If EM policymakers maintain restrictions on capital inflows, which of the following factors
b. quoted at negative forward points.
should Sanchez most appropriately identify as increasing the probability of a currency crisis
c. worth less in the forward market than in the spot market.
for EM?
8. Question 2 of 6
a. Having a persistent trade imbalance
b. Failing to liberalize restrictions on capital flows
Which of the implications cited by Sanchez is (are) correctly attributed to the international
Fisher effect?
a. Implication 1 only
b. Implication 2 only
c. Both Implication 1 and Implication 2
c. Establishing a floating peg against DM's currency
13. Sergio Reyes is an economist at Cuadrado Capital studying how international parity
conditions have held in certain countries. He is speaking to Andrea Gómez, a senior
currency trader at Cuadrado. Reyes tells Gómez:
Statement 1:Forward rate parity states that the forward exchange rate will be an
accurate forecast of the future spot exchange rate.
Statement 2 The international Fisher effect states that the nominal yield spread
Question 1 of 6
Which of Reyes's statements about international parity conditions is correct?
a. Statement 1
b. Statement 2
c. Statement 3
between two markets is determined solely by their expected inflation
differential.
Statement 3 Relative purchasing power parity states that the notional exchange
rate between two markets is the ratio of their broad price indexes.
Gómez asks Reyes what international parity conditions mean for expected spot exchange
rates. Reyes explains that if all key international parity conditions held, the expected spot
exchange rate would track several measures between two countries. He continues that if
certain parity conditions held, there would be no difference between the real interest rates of
the two countries.
Reyes notes that uncovered interest rate parity between Mexico and the United States has
held in recent years. He provides Gómez with the following information:
14. Question 2 of 6
If all key international parity conditions held, the implied change in the expected spot
exchange rate would most likely equal the:
a. real interest rate spread.
b. difference in GDP growth rates.
c. premium or discount on the forward exchange rate.
15. Question 3 of 6
Which of the following conditions is required for real interest rate parity to occur?
a. Forward rate parity
b. Uncovered interest rate parity
c. Absolute purchasing price parity
16. Question 4 of 6
Based on Exhibit 1, assuming uncovered interest rate parity holds, the expected USD/MXN
Reyes mentions that international parity conditions do not always hold, especially over the
short term. This allows Cuadrado to exploit certain trades, such as the carry trade. He
notes that a good carry trade opportunity is to borrow with EUR to purchase BRL. Gómez
compiles the following information and expectations on the currencies:
spot rate one year from now will be closest to:
a. 0.0477
b. 0.0480
c. 0.0493
17. Question 5 of 6
Based on Exhibit 2, the net return that Cuadrado would achieve on a one-year carry trade
between BRL and EUR is closest to:
a. 1.78%
Gómez asks Reyes if there is anything she should know about the distribution of returns for
b. 2.13%
carry trades.
c. 2.28%
18. Question 6 of 6
Which of the following best describes the returns for carry trades over time?
19. Ishita Rani is a currency trader at Inspire Bank discussing exchange rates with a newly hired
junior trader, Raj Pawar. Rani asks Pawar about the balance of payment accounts and its
impact on exchange rates. Pawar replies that the accounts can have different effects in the
a. Their distributions have fat tails and negative skew.
short term and long term. He elaborates by stating that over the long term, the current
b. Frequent volatility makes extended periods of positive returns rare.
account affects exchange rates through three channels:
c. Carry trades unwind gradually as traders tend to purchase long-term investments.
Channel 1:A current account deficit will result in decreased relative demand for that
country's currency, leading to currency depreciation.
Channel 2:Countries with current account surpluses may rebalance their unbalanced
foreign currency portfolios, positively impacting the foreign currencies.
Channel 3:Investors in countries running persistent current account deficits will revise their
exchange rate expectations upward until the country stabilizes its debt-to-GDP
ratio.
Rani also wants to gauge Pawar's knowledge of how monetary and fiscal policies can affect
exchange rates. She tells Pawar that Country X, an emerging market, has recently
instituted more expansionary monetary and fiscal policies. She adds that Country X has
had high capital mobility in recent years.
Pawar remembers reading about a currency crisis that happened several years ago in
Country X. Rani states that although not all currency crises show all the expected warning
signs, the crisis in Country X did in fact show some warning signs that investors ignored at
the time.
Pawar notes that some governments have taken steps to control their exchange rates. He
asks Rani if countries can actually influence their exchange rates, and if so, whether
countries with developed or developing economies would be more effective in doing so.
Rani also wants to test Pawar's skills at valuing currency-based transactions. She tells
Pawar that 3 months ago, Inspire initiated a forward contract to purchase NOK 7.5 million in
6 months. At the initiation of the contract, the 6-month forward exchange rate was INR/NOK
8.0000. She gives Pawar the current exchange rate information for the two currencies and
asks him to mark the contract to market:
Rani notes that the INR risk-free rate is 2.5% and that Inspire uses a 360-day count
convention.
23. Question 5 of 6
All else equal, which type of economy should have a relative advantage in strengthening the
level of its exchange rates through central bank intervention?
Question 1 of 6
In the short term, which balance of payments account will least likely affect a country's
exchange rate?
a. Capital account
b. Current account
c. Financial account
20. Question 2 of 6
Regarding the current account's effect on exchange rates, which of the channels identified
by Pawar is correctly described?
a. Channel 1
b. Channel 2
c. Channel 3
21. Question 3 of 6
Based on the Mundell-Fleming model, the changes to Country X's monetary and fiscal
policies will most likely have which of the following effects on its currency?
a. Currency will depreciate
b. Indeterminate effect
c. Currency will appreciate
22. Question 4 of 6
Which of the following, had it occurred, would most likely have been considered a warning
sign of currency crisis in Country X?
a. Its ratio of M2 to bank reserves fell.
b. Its ratio of exports to imports deteriorated.
c. It tightened capital market access to restrict the free flow of capital.
a. Developed markets
b. Developing markets
c. Neither will be more effective than the other
24. Question 6 of 6
Based on Exhibit 1, the mark-to-market value of Inspire Bank's forward contract (in INR) is
closest to:
a. 5,218,491
b. 6,896,441
c. 7,442,683
25. Sylvia Yang manages a team of currency analysts for an international bank. Abe Kim is
applying for a position as a junior analyst on Yang's team. During an interview, Yang asks
Kim to discuss arbitrage pricing relationships and the international parity relationships that
influence currency values.
To assess Kim's familiarity with the relationship between spot and forward exchange rates,
Yang asks Kim to determine the forward discount or premium of MXN relative to INR based
on the information in Exhibit 1:
Question 1 of 6
Based on Exhibit 1, the 180-day forward discount or premium on MXN relative to INR is
closest to:
a. −0.0281
Yang then asks Kim to interpret the implications reflected in the spot and forward rate
b. −0.0019
quotes for CHF/EUR shown in Exhibit 2:
c. 0.0019
26. Question 2 of 6
Based on the forward point quotes in Exhibit 2, Kim's most appropriate conclusion is that
a. CHF is expected to depreciate relative to EUR.
b. CHF is trading at a forward premium relative to EUR.
c. the negative forward points result from the negative interest rates.
27. Question 3 of 6
Yang follows up by asking Kim to describe and evaluate international parity relationships.
During the discussion, Kim makes the following statements regarding different versions of
purchasing power parity (PPP):
Statement 1:In the long run, currency exchange rates tend to move toward values implied
Which of Kim's statements regarding the different versions of PPP is (are) correct?
a. Statement 1 only
b. Statement 2 only
c. Both Statement 1 and Statement 2
by absolute PPP.
Statement 2:Under relative PPP, spot exchange rate changes are completely determined by
28. Question 4 of 6
differences in actual inflation, whereas under ex-ante PPP, expected spot
exchange rate changes are based on differences in expected inflation.
Real interest rate parity is most likely a requirement for which of the following parity
relationships?
Yang wants to assess Kim's understanding of arbitrage pricing. She shows him Currency
Dealer Z's quotes (Exhibit 3) and asks him to determine the potential arbitrage profit from
a. International Fisher effect
investing EUR 1 million if Dealer X quotes NOK/EUR at 9.6200/9.6530.
b. Uncovered interest rate parity
c. Relative purchasing power parity
29. Question 5 of 6
If traders can earn an arbitrage profit, which of the following parity relationships has most
likely been violated?
a. Ex-ante PPP
b. Forward rate parity
c. Covered interest rate parity
30. Question 6 of 6
Based on Exhibit 3 and Dealer X's quote, the profit from investing EUR 1 million in a
triangular arbitrage is closest to:
a. EUR 627
b. EUR 1,093
c. EUR 5,549