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Take the Quiz: Foreign Currency Exchange

By Frances Coppola

The world of foreign exchange gave finance professionals a lot to think about over the course of 2017, ranging from sporadic volatility and the unanticipated behavior of one particularly popular currency, to the strange effects of negative interest rates. How is a business finance professional to keep up with the rapidly changing foreign exchange landscape?

Here's one way to catch up. What follows are 12 questions that let finance professionals test their smarts on the exchange rate and monetary policy facts and trends of last year (2017), which may well affect their jobs.

 

Currencies

 

1. Which currency started 2017 on a high, but unexpectedly spent much of the year with a declining exchange rate?

 

A. Australian dollar
B. British pound
C. U.S. dollar
D. Japanese yen

 

Answer: C. The U.S. dollar's exchange rate soared towards the end of 2016, and many analysts expected it to continue to rise in 2017. But instead, it fell steadily from January to September.

 

2. Which currency is historically a favorite for carry trades?

 

A. Japanese yen
B. Euro
C. British pound
D. Australian dollar

 

Answer: A. The Japanese yen has historically been a favorite for foreign exchange "carry trades" because Japan's "lost decade" has meant interest rates persistently below those of the U.S. In a carry trade, investors borrow in a low-interest rate currency to purchase interest-bearing assets in a high-interest rate currency, making money on the interest rate difference.

 

3. Which currencies are currently in the International Monetary Fund's SDR basket?

 

A. U.S. dollar, Japanese yen, Swiss franc, British pound, Euro
B. U.S. dollar, Japanese yen, British pound, Euro, Chinese yuan
C. U.S. dollar, Chinese yuan, British pound, Euro, Swiss franc
D. U.S. dollar, Japanese yen, Chinese yuan, Swiss franc, Euro

 

Answer: B. The currencies included in the IMF's SDR basket are the major international reserve currencies. From 1999 to 2015 these were the U.S. dollar, the Euro, the British pound and the Japanese yen. The Chinese yuan was added in November 2015. Although it is an international "safe haven" currency, the Swiss franc is not part of the SDR basket.

 

Exchange Rates

 

4. What was the name of the international managed exchange rate system briefly adopted in 1985?

 

A. The Snake in the Tunnel
B. The Plaza Accord
C. The Louvre Accord
D. Bretton Woods

 

Answer: B. The Plaza Accord was an international agreement under which central banks collectively intervened in the FX market to reduce the dollar's exchange rate. It was ended by the Louvre Accord of 1987.

 

5. In the famous economists' trilemma, what three things cannot coexist?

 

A. Floating exchange rates, capital controls and independent monetary policy
B. Fixed exchange rates, capital controls and independent monetary policy
C. Floating exchange rates, free movement of capital and independent monetary policy
D. Fixed exchange rates, free movement of capital and independent monetary policy

 

Answer: D. The economists' trilemma says that it is not possible simultaneously to have fixed exchange rates, free movement of capital and an independent monetary policy.

 

6. Why might oil and commodities exporters choose to peg their currency exchange rates to the U.S. dollar when prices are rising?

 

A. To dampen exchange rate volatility arising from oil and commodity price changes
B. To build up FX reserves
C. To prevent "Dutch disease," in which inflows of investment into extractive industries drive up the exchange rate, making other export industries uncompetitive
D. All of the above

 

Answer: D.

 

FX Risk Management

 

7. What type of forex hedging product enables the purchaser to benefit from positive exchange rate movements while protecting from losses due to negative ones?

 

A. Forward contract
B. Option
C. Swap
D. Future

 

Answer: B. An option gives the purchaser the right but not the obligation to buy (or sell) a foreign currency. The purchaser of an option will therefore buy (or sell) if the exchange rate moves in his favor, but not if it moves against him.

 

8. Which of these is NOT a type of forex option?

 

A. Forex collar
B. Long straddle
C. Non-deliverable forward
D. Participation forward

 

Answer: C. A non-deliverable forward is a forward contract in which only the gain or loss caused by movement in the exchange rate since the start date is paid at maturity, not the full value of the contract. Despite the name, a participation forward is a type of FX option.

 

9. Which international indicator might a British exporter to Australia wish to keep an eye on when managing FX risk?

 

A. Oil price
B. International market price of iron ore
C. AUD-USD exchange rate
D. All of the above

 

Answer: D. As Australia's principal export is iron ore, the AUD's exchange rate is influenced by the international price of iron ore. Shipping costs for iron ore are affected by the oil price, so the iron ore price is linked to the price of oil. Both oil and iron ore are priced in U.S. dollars, so the AUD responds to movements in the USD exchange rate. The GBP-AUD exchange rate, which the British exporter is concerned about, is thus influenced by the iron ore price, the oil price and the U.S. dollar.

 

Central banks

 

10. In 2017, which central bank promised to keep interest rates "lower for longer"?

 

A. Reserve Bank of Australia
B. Bank of England
C. Bank of Japan
D. European Central Bank

 

Answer: D. Despite recovery in the Eurozone area, the European Central Bank disappointed investors by insisting that interest rates would remain low for an extended period of time.

 

11. Which of these central banks cut interest rates in 2016, only to raise them by exactly the same amount in 2017?

 

A. Federal Reserve
B. Bank of England
C. Bank of Japan
D. European Central Bank

 

Answer: B.1 The Bank of England cut rates by 0.25% in August 2016, and raised them 0.25% in November 2017.

 

12. Which of these central banks routinely uses capital controls to manage the currency exchange rate?

 

A. European Central Bank
B. Bank of Japan
C. People's Bank of China
D. Reserve Bank of India

 

Answer: C. The People's Bank of China controls the yuan's exchange rate with a combination of capital controls and FX market intervention. The Reserve Bank of India also occasionally uses ad-hoc capital controls to dampen high exchange rate volatility, but its capital control framework is principally intended to maintain balanced trade and keep inflation under control. The European Central Bank (ECB) does not use capital controls, though two Eurozone countries have used them. However, both the Bank of Japan and the ECB use quantitative easing (QE), one effect of which is to lower their currency exchange rates.

 

Frances Coppola - The Author

The Author

Frances Coppola

With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.

Sources

1. “The Bank of England Just Raised Interest Rates for the First Time in 10 Years,” Fortune; http://fortune.com/2017/11/02/the-bank-of-england-just-raised-interest-rates-for-the-first-time-in-10-years/

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