Chapter 1: Exchange Rates and Forex Business (CAIIB – Paper 2)
1. Which of the following best defines the Foreign Exchange Market?
A. A place where gold and commodities are traded
B. A centralized exchange for foreign currencies
C. A global decentralized market for buying and selling foreign currencies
D. A market dealing only in government securities
The Foreign Exchange Market is a global decentralized market where participants trade in different currencies, primarily to facilitate international trade, investment, and hedging. It is not centralized like stock exchanges.
2. Which of the following is a major factor influencing exchange rate movements in the short term?
A. Changes in natural resources
B. Long-term demographic trends
C. Structural reforms in the economy
D. Interest rate differentials between countries
In the short term, exchange rates are highly sensitive to capital flows and interest rate differentials. Higher interest rates in a country attract foreign capital, increasing demand for its currency.
3. Which of the following participants is not typically part of the foreign exchange market?
A. Commercial Banks
B. Retail shopkeepers
C. Central Banks
D. Multinational Corporations
Participants in the foreign exchange market include commercial banks, central banks, brokers, hedge funds, and multinational corporations. Retail shopkeepers do not directly participate in forex markets.
4. Under the Purchasing Power Parity (PPP) theory, exchange rates are primarily influenced by:
A. Relative inflation rates between two countries
B. Differences in fiscal deficit levels
C. Political stability alone
D. Foreign exchange reserves
The Purchasing Power Parity (PPP) theory states that currencies adjust to reflect changes in relative inflation rates. Higher inflation in one country leads to depreciation of its currency against others.
5. Which of the following events is most likely to cause an appreciation of the domestic currency?
A. Higher inflation compared to trading partners
B. Increase in imports without matching exports
C. Large capital inflows due to foreign investment
D. Rising fiscal deficit
When foreign investors bring capital into a country (FDI or portfolio investment), the demand for the domestic currency rises, leading to appreciation. Inflation and trade deficits usually weaken the currency.
6. In a fixed exchange rate system, the value of a currency is:
A. Determined freely by market demand and supply
B. Pegged to another currency or a basket of currencies by the government
C. Constantly fluctuating with capital inflows
D. Determined only by exports and imports
In a fixed exchange rate system, the government or central bank pegs the domestic currency to another currency (like USD) or a basket of currencies, maintaining stability.
7. Which of the following best describes a “Managed Float” exchange rate system?
A. Currency value fixed permanently by law
B. Exchange rate determined only by central bank intervention
C. Exchange rate freely determined without any regulation
D. Exchange rate determined by market forces with occasional central bank intervention
A managed float system (also called dirty float) is where the currency is allowed to fluctuate by demand and supply but central banks intervene occasionally to stabilize excessive volatility.
8. Under a floating exchange rate system, if demand for foreign currency rises, the domestic currency will:
A. Depreciate in value
B. Appreciate in value
C. Remain unaffected
D. Get pegged by the government automatically
In a floating exchange rate system, demand and supply decide currency value. Higher demand for foreign currency (say USD) leads to depreciation of the domestic currency (INR).
9. If the 3-month forward rate of USD/INR is higher than the spot rate, the rupee is said to be at:
A. Discount
B. Stable
C. Premium
D. Parity
When forward rate is higher than the spot rate, the domestic currency (rupee) is at a forward premium. If forward rate is lower, it is said to be at discount.
10. Which institution in India primarily intervenes in the forex market to maintain exchange rate stability?
A. Reserve Bank of India (RBI)
B. Ministry of Finance
C. SEBI
D. Export-Import Bank of India
In India, the Reserve Bank of India (RBI) intervenes in the foreign exchange market by buying/selling foreign currency to control excessive volatility and maintain stability.
11. In a bank’s Foreign Exchange Dealing Room, the primary function of the front office is:
A. Risk monitoring and compliance
B. Settlement of forex deals
C. Maintaining regulatory reporting
D. Execution of forex deals and trading with counterparties
The front office in a forex dealing room is responsible for execution of trades with customers and counterparties. Mid-office handles risk monitoring, while back-office manages settlement and confirmation.
12. Which of the following is the main role of the mid office in forex dealing operations?
A. Making speculative trades in the market
B. Monitoring risks, compliance, and limit adherence
C. Settlement of trades through SWIFT
D. Preparing customer deal slips
The mid-office ensures that dealers operate within approved risk limits, monitors open positions, and ensures compliance with internal and regulatory guidelines.
13. Back office in the forex dealing room is mainly responsible for:
A. Confirmation, settlement, and accounting of forex deals
B. Negotiating rates with customers
C. Monitoring market risk positions
D. Managing interest rate swaps
The back office handles post-trade activities including confirmation with counterparties, settlement of payments, reconciliation, and maintaining accounting records.
14. A swap transaction in the forex market typically involves:
A. Buying foreign currency for spot delivery only
B. Selling foreign currency for forward delivery only
C. Simultaneous purchase and sale of the same currency for different maturities
D. Arbitrage between two different markets
A forex swap is a simultaneous purchase and sale of the same currency for two different value dates (e.g., buy spot and sell forward).
15. In forex dealing operations, which global messaging system is widely used for payment confirmations and settlements?
A. NEFT
B. RTGS
C. UPI
D. SWIFT
The SWIFT (Society for Worldwide Interbank Financial Telecommunication) network is used globally by banks to send secure financial messages, confirmations, and payment instructions.
16. Which of the following is the most basic derivative product in foreign exchange markets?
A. Forward contract
B. Currency option
C. Currency future
D. Swap agreement
A forward contract is the simplest derivative in forex where two parties agree to exchange currencies at a predetermined rate on a future date. It is the foundation for other derivatives like futures, options, and swaps.
17. Which key difference distinguishes currency futures from currency forwards?
A. Futures are traded OTC, forwards on exchanges
B. Both are always customized contracts
C. Futures are standardized and traded on exchanges, forwards are customized OTC contracts
D. Futures cannot be used for hedging, only speculation
Currency futures are standardized contracts traded on exchanges with daily margining. Forwards are tailor-made contracts between parties in the OTC market without daily settlement.
18. A company buys a currency call option. What right does this provide?
A. Obligation to sell currency at a fixed rate in future
B. Right to buy currency at a predetermined rate on or before expiry
C. Right to sell currency at a predetermined rate
D. Obligation to buy currency irrespective of market price
A call option gives the holder the right (not obligation) to buy currency at a fixed strike price within a specified period. A put option gives the right to sell.
19. Which of the following best describes a currency swap?
A. Exchange of currencies for spot delivery only
B. Hedging against inflation risks
C. Agreement to borrow in one currency and repay in another without exchanging principals
D. Agreement to exchange principal and interest payments in one currency for those in another
A currency swap involves exchanging principal and interest payments in one currency for those in another. It helps companies manage currency and interest rate risks in long-term funding.
20. In derivative trading, a hedger mainly participates to:
A. Protect against adverse movements in currency or interest rates
B. Earn speculative profits through high leverage
C. Act as regulator in the market
D. Provide settlement infrastructure
Hedgers use derivative products (forwards, futures, options, swaps) to protect themselves against unfavorable movements in exchange or interest rates. Speculators, on the other hand, seek profits by taking risks.
21. As per RBI guidelines, which of the following entities is authorized to deal in foreign exchange in India?
A. All scheduled commercial banks
B. Only Authorized Dealers (Category I, II, III) licensed by RBI
C. Any financial institution registered with SEBI
D. Cooperative societies dealing in foreign remittances
In India, only Authorized Dealers (AD Category I, II, III), Money Changers, and certain entities approved by RBI can conduct foreign exchange business. Not all banks or financial institutions are permitted.
22. FEDAI rules are primarily applicable to:
A. Export-Import licensing
B. Stock market trading
C. RBI monetary policy operations
D. Standardization of forex transactions and practices among Authorized Dealers
FEDAI (Foreign Exchange Dealers’ Association of India) issues rules and guidelines on forex contracts, charges, documentation, and practices to ensure uniformity among Authorized Dealers.
23. As per RBI guidelines, all forex transactions above prescribed limits must be reported through which system?
A. SWIFT
B. UPI
C. RBI’s EDPMS/IDPMS (Export/Import Data Processing and Monitoring System)
D. Ministry of Finance MIS portal
RBI mandates reporting of export and import-related forex transactions through EDPMS (Export Data Processing and Monitoring System) and IDPMS (Import Data Processing and Monitoring System) for compliance monitoring.
24. Which of the following is not true about RBI’s Liberalized Remittance Scheme (LRS) for individuals?
A. Individuals can remit up to USD 250,000 per financial year for permissible transactions
B. LRS can be used for remitting funds for gambling and lottery tickets
C. LRS can be used for foreign education and investments
D. PAN is mandatory for availing remittances under LRS
Under LRS, Indian residents can remit up to USD 250,000 per year for education, travel, investments, etc. However, remittances for prohibited activities like lottery, gambling, and margin trading are not allowed.
25. As per FEDAI guidelines, the exchange rate for merchant transactions in India is quoted on the basis of:
A. Cross currency rates published by IMF
B. Interbank overnight call money rate
C. RBI’s monetary policy repo rate
D. Interbank market rates with FEDAI-prescribed margins
Merchant forex rates in India are derived from prevailing interbank market rates, with margins prescribed by FEDAI. This ensures uniformity and protects customers against excessive charges.
26. If 1 USD = ₹83.20/83.40, the quotation is an example of:
A. Direct quote for a US resident
B. Direct quote for an Indian resident
C. Indirect quote for an Indian resident
D. Cross rate quote
In India, when foreign currency is expressed in terms of home currency (₹ per USD), it is a direct quotation. Thus 1 USD = ₹83.20/83.40 is a direct quote for an Indian resident.
27. Spot USD/INR = 83.20. 3-month forward = 83.60. The forward rate is at:
A. Premium of ₹0.40
B. Discount of ₹0.40
C. At par
D. Cannot be determined
Forward rate (83.60) is higher than spot rate (83.20). Hence, the foreign currency (USD) is at a forward premium of ₹0.40 against INR.
28. Cross rate: If 1 USD = ₹83.00 and 1 GBP = 1.30 USD, then 1 GBP = ? in INR.
30. A customer sells GBP 10,000 to the bank. Interbank rate is ₹108.20/108.40 per GBP. Bank applies a margin of 0.10. What rate is quoted to the customer?
A. ₹108.10
B. ₹108.20
C. ₹108.30
D. ₹108.40
Bank buying GBP → use buying rate (₹108.20). After deducting margin of 0.10, effective rate = ₹108.10 per GBP.
31. Spot USD/INR = 83.20. 3-month forward points are quoted as 35/40. What is the 3-month forward buying rate for USD?
34. As per Interest Rate Parity (IRP), if domestic interest rate is higher than foreign interest rate, then forward currency should quote at:
A. Premium
B. Discount
C. At par
D. Arbitrage-free
Under IRP, the currency with higher interest rate depreciates forward.
If domestic rate > foreign rate, domestic currency will depreciate, so foreign currency quotes at forward premium.
35. Arbitrage: In London, 1 GBP = 1.30 USD. In New York, 1 GBP = 1.32 USD. What opportunity exists?
A. No arbitrage, rates aligned
B. Buy GBP in New York, sell in London
C. Buy GBP in London, sell in New York
D. Buy USD in London, sell in New York
GBP cheaper in London (1.30 USD) and more expensive in New York (1.32 USD).
Arbitrageurs can buy GBP in London and sell in New York for profit.
