L2 R11 CERD Q-Bank Set 2 With Answer

Level II R11 Currency Exchange Rates:
Determination and Forecasting

Test Code: L2 R11 CERD Q-Bank Set 2
Number of questions: 57
Question Q-Code: L2-EC-CERD-014 LOS a Section 2
1 The interbank spot rate quotes for USD/MXN and MXN/EUR are presented below:
USD/MXN = 0.0480/0.0490
MXN/EUR = 21.82/21.87
The bid/offer on the USD/EUR cross rate implied by the interbank market is closest to:
A) 0.002/0.002.
B) 1.0474/1.0716.
C) 1.0498/1.0690.
Answer B) 1.0474/1.0716.
Explanation B is correct.
( USD/EUR )bid = ( USD/MXN )bid x ( MXN/EUR )bid = 0.0480 x 21.82 = 1.0474.
( USD/EUR )offer = ( USD/MXN )offer x ( MXN/EUR )offer = 0.0490 x 21.87 = 1.0716.
Section 2.1 LO.a.
2 The interbank spot rate quotes for EUR/PHP and EUR/MXN are presented below:
EUR/PHP = 0.018/0.019
EUR/MXN = 0.8586/0.8584
The bid/offer on the PHP/MXN cross rate implied by the interbank market is closest to:
A) 0.0154/0.0163.
B) 45.1895/47.6927.
C) 45.1771/47.6954.
Answer B) 45.1895/47.6927.
Explanation B is correct. ( PHP/MXN )bid = ( PHP/EUR )bid x ( EUR/MXN )bid = (1/0.019) x 0.8586 = 45.1895
( PHP/MXN )offer = ( PHP/EUR )offer x ( EUR/MXN )offer = (1/0.018) x 0.8584 = 47.6927
Section 2.1. LO.a.
Question Q-Code: L2-EC-CERD-016 LOS b Section 2
3 Danny Oglivy is a forex trader with NMI Inc, a leading international bank. Rohit Kapoor, an intern at NMI, is learning how to determine if
there is a potential for triangular arbitrage. Oglivy uses three currencies, INR, PKR and USD to explain the concept to Kapoor. The
interbank spot rates for INR/USD and PKR/USD are given below:
INR/USD = 68.2210/68.2450
PKR/USD = 104.7500/104.9500
A dealer quotes a bid-offer rate of 0.6460/0.6490 in INR/PKR.
Oglivy’s steps for a triangular arbitrage would most likely involve:
A) buying INR from the dealer and selling it in the interbank market.
B) buying PKR from the dealer and selling it in the interbank market.
C) buying PKR in the interbank market and selling it to the dealer
Answer B) buying PKR from the dealer and selling it in the interbank market.
Step 1: Calculate the interbank implied cross rate for INR/PKR.
( INR/PKR )bid = ( INR/USD )bid x ( USD/PKR )bid = 68.2210 x 1/104.9500 = 0.6500.
( INR/PKR )offer = ( INR/USD )offer x ( USD/PKR )offer = 68.2450 x 1/104.7500 = 0.6515.
Step 2: Compare the dealer’s offer rate and the interbank bid rate. Since the dealer’s offer rate of 0.6490 is below the interbank bid
rate of 0.6500, triangular arbitrage will involve buying PKR (base currency) from the dealer and selling PKR in the interbank market.
Section 2.1. LO.b.
4 The bid-offer on the INR/PKR cross rate implied by the interbank market is 0.6500/0.6700. A dealer quotes a bid-offer rate of
0.6300/0.6600 in INR/PKR. A customer is assessing whether engaging in triangular arbitrage will result in profits. In this case:
A) there is no arbitrage opportunity.

B) an arbitrage profit can be made by buying PKR from the dealer and selling PKR in the interbank market.
C) an arbitrage profit can be made by buying INR from the dealer and selling INR in the interbank market.
Answer A) there is no arbitrage opportunity.
Explanation A is correct. Compare the dealer’s offer and interbank bid rate. There is no arbitrage opportunity because the dealer’s offer of 0.6600
is higher than the interbank bid of 0.6500. Section 2.1 LO.b.
5 An analyst is considering the following three transactions involving Indian rupee (INR), United States dollar (USD), and Chilean Peso
(CLP):
Transaction 1: Buy INR 5 million against the USD at 15:30 Mumbai time.
Transaction 2: Sell INR 100 million against the CLP at 2:30 Mumbai time.
Transaction 3: Buy CLP 50 million against the USD at 14:30 Santiago time.
Which transaction will most likely have the widest bid-offer spread under normal market conditions?
A) Transaction 1.
B) Transaction 2.
C) Transaction 3.
Answer B) Transaction 2.
Explanation B is correct. INR/CLP is the least liquid among the given currency pairs. The transaction is for a larger amount that occurs outside the
normal trading hours. Section 2 LO.a.
6 Alec Hopkins is an analyst at the corporate finance department of a major operation analytics company with clients all over the world.
One of his responsibilities is to hedge currency risk and look for triangular arbitrage opportunities. The interbank currency rates for
the currency pairs he regularly monitors are presented below:
EUR/GBP = 1.1592/1.1597
AUD/GBP = 1.6770/1.6778
USD/EUR = 1.0591/1.0596
A dealer quotes a bid/offer AUD/EUR rate of 1.4400/1.4440. A triangular arbitrage would most likely involve buying 1 EUR from the
dealer and selling it in the interbank market for a profit of:
A) AUD 0.001.
B) AUD 0.002.
C) AUD 0.007.
Answer B) AUD 0.002.
Step 1: Calculate the AUD/EUR bid-offer cross rate implied by the interbank market.
AUD/EUR bid = AUD/GBP bid x GBP/EUR bid = 1.6770 x (1/1.1597) = 1.4461
AUD/EUR offer = AUD/GBP offer x GBP/EUR offer = 1.6778 x (1/1.1592) = 1.4474
Step 2: Compare the dealer’s offer rate and the interbank bid rate. The dealer’s offer rate of 1.4440 is below the interbank bid rate
of 1.4461. The arbitrage would involve buying 1 EUR (base currency) from the dealer and selling it in the interbank market.
profit from the transaction = 1.4461 – 1.4440 = AUD 0.0021
Section 2.1 LO.b.
7 Brendan Rosner manages a global equity fund based in Hong Kong. He is evaluating stocks from Japan and New Zealand to add to
the portfolio. As part of his evaluation, he is also considering the impact of interest rates, exchange rates and inflation in these
countries. He has gathered the following currency and market rates:
Country Currency Spot Exchange Rate **
Hong Kong HKD NA

JAPAN JPY 14.07 / 14.08
New Zealand NZD 0.1800 / 0.1900
** Number of foreign currency units per one HKD
If a dealer’s bid-side quote for JPY/NZD is 78.45, then a profit on a HKD 100,000,000 investment in the triangular arbitrage
opportunity is closest to:
A) HKD 291,193.
B) HKD 362,473.
C) HKD 5,862,926.
Answer A) HKD 291,193.
Explanation A is correct. Given that there is a triangular arbitrage opportunity, compare the dealer’s bid rate with the interbank offer rate. Dealer
JPY/NZD bid = 78.45 (given).
Interbank JPY/NZD offer = JPY/HKD offer x HKD/NZD offer = 14.08 x 1/0.18 = 78.22.
Therefore, buy NZD (sell JPY) in the interbank market and sell NZD (buy JPY) in the dealer market. On a HKD 100,000,000 investment,
buy NZD at 0.18 in the interbank market = 100,000,000 x 0.18 = NZD18,000,000.
Sell NZD to the dealer at 78.45 = 18000,000 x 78.45 = JPY1,412,100,000.
Sell JPY in the interbank market at 14.08 = 1,412,100,000/14.08 = HKD100,291,193.
Hence profit = HKD(100,291,193-100,000,000) = HKD291,193. Section 2.1 LO.b.
8 A group of currency dealers in Europe are analyzing the currency rates presented in Exhibit 1 to exploit arbitrage opportunities.
Currency pair Spot rate
Interbank Market
Bid Offer
SEK / EUR 9.8100 9.8300
GBP / EUR 0.8581 0.8585
Dealer in Sweden
GBP / SEK 0.0881 0.0892
Which of the following is most likely correct regarding the outcome of their analysis? There is (are):
A) no arbitrage opportunities.
B) a profitable opportunity to buy GBP in the interbank market and sell GBP to the Swedish dealer.
C) a profitable opportunity to buy GBP from the Swedish dealer and sell GBP in the interbank market.
Answer C) a profitable opportunity to buy GBP from the Swedish dealer and sell GBP in the interbank market.
Explanation C is correct.
Step 1: Calculate the interbank implied cross rate for GBP/SEK.
GBP/SEK bid = GBP/EUR bid x EUR/SEK bid = 0.8581 x 1/9.8300 = 0.0873.
GBP/SEK offer = GBP/EUR offer x EUR/SEK offer = 0.8585 x 1/9.8100 = 0.0875.
Step 2: Compare the dealer’s bid rate with the interbank offer rate. The interbank offer is less than the dealer’s bid. An arbitrage will
involve buying SEK in the interbank market and selling SEK to the dealer. i.e. selling GBP in the interbank and buying GBP from the
dealer
Section 2.1. LO.b.
Question Q-Code: L2-EC-CERD-022 LOS c Section 2
9 The average bid-offer for the current AUD/NZD spot exchange rate is 0.95. The NZD and AUD 180-day annualized Libor rates are
given below:
180-day Libor (NZD): 3.21%
180-day Libor (AUD): 2.83%
The forward premium(discount) for a 180-day forward contract for AUD/NZD would be closest to
A) -0.0036.
B) -0.0031.
C) -0.0018.
Answer C) -0.0018.
Explanation C is correct. NZD is the base currency and AUD is the price currency in AUD/NZD quote. Calculate the forward rate of AUD/NZD: F =
S x (1 + price currency rate x n/360) / (1 + base currency rate x n/360)
F = 0.95 x (1+ 0.0283 x 180/360) / (1 + 0.0321 x 180/360) = 0.95 x (1.01415)/(1.01605) = 0.9482.
Calculate the forward premium (discount) = F – S = 0.9482-0.9500 = -0.0018
Section 2.2. LO.c.
10 Cruxia is a developing island nation focused on exports. Cruxia’s currency is CRX. Rita Campbell, an analyst, is studying the
prospects, its exchange rate interplay and interest rates. She has gathered the following data:
Country Currency Pair Spot rate 1-year interest

rate (%)
Cruxia CRX / USD 51.0200 8.2 %
Canada CAD / USD 1.3427 0.5 %
United States NA NA 0.25%
Based on the data given above, the one-year forward exchange rate of CRX/CAD is closest to:
A) 35.286
B) 39.865.
C) 40.900.
Answer C) 40.900.
Explanation C is correct.
Step 1: Determine the CRX/CAD cross rate.
CRX/CAD = CRX/USD x USD/CAD = 51.0200 x (1/1.3427) = 37.9981 = 38.0000 approx.
Step 2: Calculate the forward rate of CRX/CAD: F = S x (1 + price currency rate x n/360) / (1 + base currency rate x n/360). F = 38 x
(1+ 0.082)/(1+0.005) = 40.9114. Section 2.2. LO.c.
Question Q-Code: L2-EC-CERD-024 LOS d Section 2
11 The information below relates to next 3 question
Three months ago, a dealer sold USD 5 million forward against the EUR for a 90-day term at an all-in rate of 1.0876. Today, the dealer
wants to use an FX swap to roll this position forward for another three months. The current spot rate and forward points for the
USD/EUR currency pair are given below:
Spot rate (USD/EUR)1.0619/1.0620
One month 13.01/13.04
Two month 33.1/33.4
Three month 49.1/49.4
Four month 62.8/63.4
Five month 79.4/80.2
Six month 94.3/95.2
The current all-in four month bid rate for delivery of EUR against the USD is closest to
A) 1.0682.
B) 1.0688.
C) 63.8600.
Answer A) 1.0682.
Explanation A is correct. All-in four-month bid rate for EUR (the base currency) is equal to: 1.0619 + (62.80/10,000) = 1.06818. Section 2.2. LO.d.
12 Three months ago, a dealer sold USD 5 million forward against the EUR for a 90-day term at an all-in rate of 1.0876. Today, the dealer
One month 13.01/13.04
Two month 33.1/33.4
Six month 94.3/95.2
The cash flow that will be realized by the dealer on the settlement date will most likely be:
A) an outflow of 111,041.
B) an outflow of 111,262.
C) an inflow of 111,041.
Answer A) an outflow of 111,041.
Explanation A is correct. Three months ago, the dealer sold USD 5 million at an all-in rate of 1.0876.
This is equivalent to receiving 5,000,000 / 1.0876 = EUR 4,597,278.4 on settlement day.
Today the dealer will buy USD 5 million at a spot rate of 1.06195 to settle the maturing USD forward contract, so that USD amounts
net to zero on settlement day.
This is equivalent to selling 5000000/1.06195 = EUR 4,708,319.60
The dealer will pay EUR 4,708,319 on settlement day.
(Exam tip: with an FX swap use the mid-market rate. In this case 1.06195 represents the mid-market rate.)
These two transactions can be combined as:
5,000,000 / 1.0876 - 5,000,000 / 1.06195 = 111,041
Since the USD appreciated against the euro during the course of the forward contract, the dealer incurs an outflow. Section 2.2.
LO.d.
13 Three months ago, a dealer sold USD 5 million forward against the EUR for a 90-day term at an all-in rate of 1.0876. Today, the dealer
One month 13.01/13.04
Two month 33.1/33.4
Six month 94.3/95.2
The all-in rate that the dealer will use today to sell the USD six months forward against the EUR is closest to:
A) 1.06689.
B) 1.07147.
C) 1.07152.
Answer B) 1.07147.
Explanation B is correct. EUR is the base currency in this example. Selling the USD is equivalent to buying the EUR, hence the offer side of the
market must be used. The mid-market spot rate must be used since this is a FX swap. All-in forward price = 1.06195 +
(95.2/10,000) = 1.07147. Section 2.2 LO.d.
14 Zack Nyhan, a portfolio manager at a hedge fund in South Africa, sold GBP 20 million forward against the USD at an all-in forward price
of 1.2489 (USD/GBP). A month before the settlement date, Nyhan wants to mark this forward position to market. The relevant spot
rate, forward points, and Libor are given below.
USD/GBP 1.2456/1.2458
One month forward point 7.16/7.75
One-month Libor (USD)0.27%
One-month Libor (GBP)1.34%

The mark-to-market value for Nyhan’s forward position is closest to:
A) +USD 45,990.
B) +USD 77,500.
C) USD 46,374.
Answer A) +USD 45,990.
Explanation A is correct.
Step 1: To mark this position to market, create an offsetting position.
Nyhan sold GBP 20 million at an all-in forward price of 1.2489 (USD/GBP). The offsetting position would be to buy GBP 20 million one
month forward to the settlement date.
Step 2: Determine the all-in forward rate for this position.
GBP is the base currency. Buying GBP means paying the offer rate for both spot rate and forward points.
The all-in one-month forward rate = 1.2458 + 0.000775 = 1.246575.
Step 3: Calculate the cash flow at settlement day.
Net cash flow on settlement day = 20,000,000 (1.2489 – 1.2466) = USD 46,000
Step 4: Calculate the present value of the cash flow at the future settlement date.
Use the one-month USD discount rate to calculate the mark-to-market value.
Mark-to-market value = ( USD46,000) / ( 1 + 0.0027 (30 / 360) = 45,989.65
Section 2.3. LO.d.
15 Zack Nyhan, a portfolio manager at a hedge fund in South Africa, sold USD 10 million forward against the GBP at an all-in forward price
of 1.2489 (USD/GBP). Two months before the settlement date, Nyhan wants to mark this forward position to market. The relevant
spot rate, forward points, and Libor are given below.
USD/GBP 1.2456/1.2458
Two month forward point 20.57/20.91
Two-month Libor (USD) 0.25%
Two-month Libor (GBP) 1.3%
The mark-to-market value for Nyhan’s forward position is closest to:
A) -GBP 21,167.
B) -GBP 7,684.
C) GBP 20,941.
Answer B) -GBP 7,684.
Explanation B is correct. Step 1: To mark this position to market, create an offsetting position.
Nyhan sold USD 10 million at an all-in forward price of 1.2489 (USD/GBP). The offsetting position would be to buy USD 10 million two
months forward to the settlement date.
Step 2: Determine the all-in forward rate for this position.
USD is the price currency and GBP is the base currency. Buying USD means selling GBP therefore using the bid rate for both spot
rate and forward points.
The all-in two-month forward rate = .1.2456 + (20.57 / 10,000) = 1.247657
Step 3: Calculate the cash flow at settlement day.
Net cash flow on settlement day = 10,000,000 / 1.2489 - 10,000,000 / 1.2477 = 8,007,046 – 8,014,747 = GBP -7,701.
Step 4: Calculate the present value of the cash flow at the future settlement date.
Use the two-month GBP Libor to calculate the mark-to-market value.
Mark-to-market value = (GBP - 7,701) / (1 + 0.013(60/360)) = GBP -7,684.
Section 2.3. LO.d.
16 The DKK/USD spot rate is 6.9900/7.0000. The forward points on a six-month forward contract are 100/120. If you want to sell USD in
the forward market, the relevant rate is:
A) 7.0000.
B) 7.0020.
C) 7.0120.
Answer A) 7.0000.
Explanation A is correct. You want to sell USD (base currency). This means the dealer will buy Hence the relevant rate is the bid rate. The forward
rate will be 6.9900 + 100/10,000 = 7.0000. Section 2.2. LO.c.
17 The information below relates to next 3 question
Michael Brennan, is a financial advisor based in South Africa. He advises select high net worth individuals, and is analyzing two
emerging countries, India and South Africa. The data collected by Brennan is presented below:
Mid-market spot rate INR/ZAR: 4.89
One-year Indian deposit rate:8.5%
One-year South African deposit rate: 7.2%
Based on uncovered interest rate parity, the expected change in the INR/ZAR rate is closest to:
A) a decrease of 1.3 percent.

B) an increase of 1.3 percent.
C) An increase of 2.0 percent.
Answer B) an increase of 1.3 percent.
Explanation B is correct. According to the uncovered interest rate parity the expected appreciation (depreciation) of the INR/ZAR rate is equal to
the interest rate differential between India and South Africa (8.5% and 7.2%) = 8.5 - 7.2 = 1.3% appreciation of INR/ZAR rate. Section
3.1.2. LO.e.
Question Q-Code: L2-EC-CERD-031 LOS e Section 3
18 Michael Brennan, is a financial advisor based in South Africa. He advises select high net worth individuals, and is analyzing two
If the analyst expects future INR/ZAR spot rate to equal the forward rate, he is least likely assuming that:
A) uncovered interest rate parity holds.

B) investors are risk neutral.
C) spot rates follow a random walk.
Answer C) spot rates follow a random walk.
Explanation C is correct. The expected future spot rate is equal to the forward rate if we assume that uncovered interest rate parity holds. We
also assume that investors are risk neutral. Spot rates do not follow a random walk as current interest rate spreads determine
expected exchange rate movements. Section 3.1.3. LO.e.
19 Michael Brennan, is a financial advisor based in South Africa. He advises select high net worth individuals, and is analyzing two
The INR/ZAR spot rate one year from now is forecasted to be 4.89. This forecasting least likely assumes that:
A) spot rates follow a random walk.

B) uncovered interest rate parity holds.
C) it is not necessary for uncovered interest rate parity to hold.
Answer B) uncovered interest rate parity holds.
Explanation B is correct. If uncovered interest rate parity holds, then current spot rate will not be a predictor of future spot rates unless interest
rate differential is equal to 0. If the current INR/ZAR spot rate is the best predictor of future spot rates, then the assumption is that
exchange rate movements follow a random walk. Section 3.1.3. LO.e.
20 Brennan recommends to a client to invest in a 1-year Indian deposit. He also recommends hedging the currency exposure to INR
using a forward rate contract. The one-year all-in holding return would be closest to:
A) 0 percent.
B) 7.2 percent.
C) 8.5 percent.
Answer B) 7.2 percent.

Explanation B is correct. Since the exposure to INR is completely hedged, the return would be what an investment in ZAR would earn, that is, 7.2
percent. This is based on covered interest rate parity that states that an investment in a foreign money market instrument that is
completely hedged should give the same return as an otherwise domestic money market investment. Section 3.1.3. LO.e.
21 “Identical goods should trade at the same price across countries valued in terms of a common currency.” This is the principle behind
which of the following?
A) Law of one price.

B) Absolute PPP.
C) Relative version of PPP.
Answer A) Law of one price.
Explanation A is correct. Absolute PPP and relative version of PPP are based on the law of one price. Section 3.1.4. LO.e.
22 According to uncovered interest rate parity, which of the following statements is most likely correct?
A) Investors are risk averse.

B) The current exchange rate is a good predictor of the future spot exchange rate.
C) Expected change in the spot rate over an investment horizon is equal to the interest rate differential between the two countries.
Answer C) Expected change in the spot rate over an investment horizon is equal to the interest rate differential between the two countries.
Explanation C is correct. %∆Sep/b = ip - iB. The expected change in spot rate on average should equal the interest rate differential between two
countries over an investment period. Section 3.1.2. LO.e.
23 Which of the following equations best describes the covered interest parity relationship?
1+iP( actual
360 )
A) F P = S P [ ]
B B 1+iB( actual
360 )
1+iP( actual
360 )
B) S P = F P [ ]
B B 1+iB( actual
360 )
1+iB( actual
360 )
C) F P = S P [ ]
B B 1+iP( actual
360 )
Answer 1+iP( actual

360 )
A) F P = S P [ ]
B B 1+iB( actual
360 )
Explanation A is correct. The covered interest rate parity condition gives the relationship among the forward exchange rate, spot rate, and
interest rates. Section 3.1.1. LO.e.
24 The following information relates to the next three questions:
An analyst is evaluating the relative merit of investing in three countries: Norway(NOK), United Kingdom (GBP), and Switzerland(CHF).
He has collated data on their exchange rates and interest rates presented below. Use the following information to answer questions
24-26.
Country One year Libor Currency pair Spot rate
NOK 1.05% NOK/GBP 10.5800/10.5900
GBP 0.56% CHF/GBP 1.2510/1.2550
CHF -1.25% NOK/CHF 8.4610/8.4650
Assuming covered interest rate parity holds, the all-in return on a one-year investment to a Swiss investor whose currency exposure
to the NOK is fully hedged is closest to:
A) 0.0 percent.
B) -1.25 percent.
C) 1.05 percent.
Answer B) -1.25 percent.
Explanation B is correct. As per covered interest rate parity, an investment in a foreign money market instrument (NOK here) that is completely
hedged should give the same return as an otherwise domestic money market investment (CHF). Section 3.1.1. LO.e.
Question Q-Code: L2-EC-CERD-038 LOS g Section 3
25 An analyst is evaluating the relative merit of investing in three countries: Norway(NOK), United Kingdom (GBP), and Switzerland(CHF).
24-26.
NOK 1.05% NOK/GBP 10.5800/10.5900
GBP 0.56% CHF/GBP 1.2510/1.2550
CHF -1.25% NOK/CHF 8.4610/8.4650
Using the midpoint of the bid-offer quote, assuming uncovered interest rate parity holds, the expected value of CHF/GBP six months
from now is closest to:
A) 1.2163.
B) 1.2285.
C) 1.2417.
Answer C) 1.2417.
Explanation C is correct. If uncovered interest rate parity holds, then expected spot rate six-months from now is equal to six-month forward
exchange rate. Bid-offer quote midpoint of CHF/GBP = (1.251+1.255)/2 = 1.253
Se = 1.253 (1+ (-0.0125/2 )) / (1 + 0.0056 / 2) = 1.2417
Sections 3.1.1, 3.1.2. LO.g.
26 An analyst is evaluating the relative merit of investing in three countries: Norway(NOK), United Kingdom (GBP), and Switzerland(CHF).
24-26.
NOK 1.05% NOK/GBP 10.5800/10.5900
GBP 0.56% CHF/GBP 1.2510/1.2550
CHF -1.25% NOK/CHF 8.4610/8.4650
Assume uncovered interest rate parity holds. The expected movement in the NOK/GBP pair one year from now is closest to:
A) 0.00 percent.
B) 0.49 percent.
C) 1.05 percent.
Answer B) 0.49 percent.
Explanation B is correct. If uncovered interest rate parity holds, then the expected movement in the spot exchange rate is equal to the interest
rate differential = 1.05 – 0.56 = 0.49 percent. Section 3.1.2. LO.g.
27 The interbank currency quotes and Libor rates for a currency pair is given below:
Spot rate: CZK/EUR = 27.0260/27.0290
One-year Libor rate CZK0.2%
One-year Libor rate EUR1.1%
Use the bid-offer quote midpoint as the current spot rate. Assuming uncovered interest rate parity holds, the expected one-year
spot rate for the CZK/EUR currency pair is closest to:
A) 26.7900.
B) 27.0250.
C) 27.2700.
Answer A) 26.7900.
Explanation A is correct. Bid-offer quote midpoint of CZK/EUR = 27.0275
Se = 27.0275( 1 + 0.002 ) / 1 + 0.011 = 26.7869 . Section 3.1.3. LO.g.

28 The spot rates for the currency pair MXN/USD is given below along with their respective expected inflation rates.
Country Currency pair Exchange rate One-year risk- Expected annual

free rate inflation rate
Mexico MXN / USD 20.6880 / 5.31% 2.72 %

20.7150
United States NA 0.5% 1.6%
According to the relative version of PPP, using the bid-offer quote midpoint, the one-year expected future spot exchange rate for
MXN/USD is closest to:
A) 20.4560.
B) 20.9300.
C) 21.6830.
Answer B) 20.9300.
Explanation B is correct. The relative version of PPP states that the percentage change in the spot exchange rate will be determined by the
difference between the foreign and domestic inflation rates. Bid-offer quote midpoint of MXN/USD = (20.6880+20.7150)/2 =
20.7015. Difference in inflation rates = πf - πd= 2.72% - 1.6% = 1.12%. One-year expected future spot exchange rate = 20.7015
(1.0112) = 20.93336. Section 3.1.4. LO.g.
29 An Indian fixed asset manager is evaluating two currencies: Indian rupee and Hong Kong dollar. The deposit rate in Hong Kong is
3.5% whereas in India it is 10.1%. Based on purchasing power parity, the Indian rupee is overvalued by 5% relative to the Hong Kong
dollar (HKD). The Indian rupee would most likely restore to its PPP value if:
A) the HKD appreciates against the INR by 5 percent.

B) Hong Kong’s inflation rate increases by 6.6 percent.
C) the Indian inflation rate increases by 5 percent.
Answer A) the HKD appreciates against the INR by 5 percent.
Explanation
A is correct. A decline of 5% in the HKD/INR exchange rate will restore the Indian rupee to its PPP value. Section 3.1.4. LO.e.
30 The one-year deposit rates for Venezuela and Russia are 16.00% and 8% respectively. Assume the real interest rates are equal in
both the countries. According to the international Fisher effect, the expected inflation differential is closest to:
A) 0 percent.
B) 8 percent.
C) 16 percent.
Answer B) 8 percent.
Explanation B is correct. If real interest rate differential is zero, then according to the international Fisher effect, the nominal yield spread between
two countries will be determined by the expected inflation differential. Hence 16 – 8 = 8% = πεf - πεd. Section 3.1.5. LO.e.
31 If real interest rates across market are equal, then the difference in nominal yields is equal to the difference between the expected
inflation rates. This relationship is best known as:
A) absolute purchasing power parity.

B) international Fisher effect.
C) interest rate parity.
Answer B) international Fisher effect.
Explanation B is correct. This relationship describes international Fisher effect. Absolute purchasing power parity states the nominal exchange
rate is the ratio of price levels of foreign and domestic price indices. Relative version of PPP equates percentage change in expected
spot rate to inflation rate differential. Section 3.1.5. LO.e.
32 Which of the following is least likely an assumption of the absolute version of PPP?
A) Consumers in different countries consume different products and services.

B) Inflation rates vary across countries.
C) All goods and services are tradable and the weights for consumption of good and services are the same in each country.
Answer A) Consumers in different countries consume different products and services.
Explanation A is correct. Absolute version of PPP does not hold in reality because consumption varies across countries. Section 3.1.4. LO.e.
33 The inflation rate, or the annual rate of price growth, in Zimbabwe and Cambodia were 25% and 3% respectively. Zimbabwean
currency is ZWD and Cambodian currency is KHR. Based on empirical evidence, which of the following statements is most likely
correct if PPP holds in the long run?
A) ZWD will appreciate relative to KHR in the long term.

B) ZWD will depreciate relative to KHR in the long term.
C) The ZWD/KHR exchange rate will move towards their equilibrium PPP value in the short-run but deviate in the long run.
Answer B) ZWD will depreciate relative to KHR in the long term.
Explanation B is correct. Currencies of countries with high inflation tend to depreciate in the long run. Over a shorter time horizon, the exchange
rate may deviate but will return to their PPP equilibrium values in the long run. Section 3.1.4. LO.g.
34 Adam Czin manages a fixed income fund. He compiles data on inflation and interest rates for three countries. Czin consults with
George Flanigan, an economic advisor, to discuss the fund’s allocations. Following their discussion on Fisher effect and international
Fisher effect, Czin decides to increase the fund’s holdings in countries with the highest real interest rate.
The data collated by Czin is presented below:
Country Current Nominal Current Inflation Rate (%) Expected Inflation Rate
(%)
Interest Rate (%)
Vitenam 11.13 6.25 6.25
Turkey 7.6 3.4 3.5
Zambia 9.1 5.1 5.25
Czin will most likely increase holdings in which of the following countries?
A) Turkey.
B) Vietnam.
C) Zambia.
Answer B) Vietnam.
Explanation B is correct. The real interest rate calculation for each of the countries is tabulated below:
Country Real interest rate = Nominal interest rate – expected inflation rate
Vietnam 11.13 – 6.25 = 4.88
Turkey 7.6 – 3.5 = 4.1
Zambia 9.1 – 5.25 = 3.85
Section 3.1.5. LO.e.
Question Q-Code: L2-EC-CERD-048 LOS f Section 3
35 Which of the following is most likely true according to the theory of covered interest rate parity?
A) Forward premium(discount) must equal the nominal interest rate spread.

B) Expected change in spot rate must equal the nominal interest rate spread.
C) Expected inflation differential must equal the nominal interest rate spread.
Answer A) Forward premium(discount) must equal the nominal interest rate spread.
Explanation A is correct. According to the covered interest rate parity, arbitrage makes it possible for nominal interest rate spreads to equal the
forward premium(discount) percentage. B is the condition for uncovered interest rate parity. C describes the international Fisher
effect. Section 3.1.6. LO.f.
36 The expected change in the spot exchange rate must equal the expected inflation differential. This exchange rate determination
approach is best known as:
A) uncovered interest rate parity.

B) ex-ante PPP.
C) absolute PPP.
Answer B) ex-ante PPP.
Explanation B is correct. Ex ante PPP approach equates the expected change in the spot exchange rate to the expected difference in domestic
and foreign inflation rates. Uncovered interest rate parity relates expected change in spot rates and interest rate differential.
Absolute PPP equates the price level of the foreign country to currency-adjusted domestic price level, such that the nominal
exchange rate is given by the ratio of foreign and domestic price indices. Section 3.1.6. LO.f.
37 If the international parity conditions held at all times, then the expected percentage change in the future spot exchange rate would
least likely equal:
A) Forward premium or discount.

B) expected inflation rate differential.
C) real yield spread.
Answer C) real yield spread.
Explanation C is correct. The expected change in the future spot exchange rate would equal the forward premium or discount, the nominal yield
spread, and the expected inflation differential if all the key international parity conditions were to hold. Section 3.1.6. LO.f.
38 For the forward exchange rate to be an unbiased predictor of the future spot exchange rate, which of the following conditions is not
necessary?
A) Covered interest rate parity.

B) Uncovered interest rate parity.
C) Purchasing power parity.
Answer C) Purchasing power parity.
Explanation C is correct. Covered and uncovered interest rate parity must hold for the forward exchange rate to be an unbiased predictor of the
future spot exchange rate. Section 3.1.6. LO.f.
Question Q-Code: L2-EC-CERD-052 LOS i Section 4
39 Which of the following positions best describe the FX carry trade strategy?
A) Long position in a high-yield currency and a short position in a funding currency.

B) Short positon in a high-yield currency and a long position in a funding currency.
C) Long position in a highly traded currency (USD) and a short position in a funding currency.
Answer A) Long position in a high-yield currency and a short position in a funding currency.
Explanation A is correct. The FX carry trade involves taking long positions in high-yield currencies and short positions in funding currencies.
Section 4. LO.i.
40 During periods of low volatility, FX carry trades are most likely to result in:
A) substantial losses.
B) positive excess returns.
C) isk-free rate.
Answer B) positive excess returns.
Explanation B is correct. In periods of low volatility, carry trade strategies result in positive excess returns. Turbulent times result in excessive
losses. Section 4. LO.i.
41 Carry trades are profitable under which of the following conditions?
A) Uncovered interest parity holds.

B) When high-yield currencies do not appreciate and low-yield currencies do not depreciate to the levels predicted by interest rate
differentials.
C) When high-yield currencies do not depreciate and low-yield currencies do not appreciate to the levels predicted by interest rate
differentials.
Answer C) When high-yield currencies do not depreciate and low-yield currencies do not appreciate to the levels predicted by interest rate
differentials.
Explanation C is correct. Carry trades are profitable when high-yield currencies do not depreciate and low-yield currencies do not appreciate to
the levels predicted by interest rate differentials. A is incorrect because uncovered interest parity must not hold for FX carry trade to
be profitable. Section 4. LO.i.
42 A Canada-based FX trader enters into a carry trade position involving the CAD and BRL. The relevant interest rates and spot
exchange rates are given below.
Country One-year Libor Currency pair Bid-Offer quote Spot rate one-
midpoint today year later
Canada 1.2% CAD / USD 1.3483 1.3402
Brazil 14.1% USD / BRL 0.2943 0.3005
The all-in return to this trade after one year, measured in CAD, would be closest to:
A) 11.23 percent.
B) 15.80 percent.
C) 14.60 percent.
Answer C) 14.60 percent.
Explanation C is correct. The carry trade involves borrowing the low-yield currency (CAD here) and investing in a higher yielding one (BRL) after
accounting for borrowing costs and exchange rate movements.
Step 1: Calculate the CAD/BRL cross rate.
CAD/BRL = 1.3483 * 0.2943 = 0.3968
Cross rate after one year is 0.4027.
Step 2:
Calculate the investment return for the unhedged Brazilian Libor deposit, measured in CAD.
1 / 0.3968 ( 1 + 0.141 ) ( 0.4027 ) = 1..1580
The gross return is 15.80%.
Step 3:
Subtract the borrowing cost from gross return to get the net return on carry trade.
15.80% - 1.20% = 14.60% Section 4. LO.i.
Question Q-Code: L2-EC-CERD-056 LOS j Section 5
43 Assume Skonia is a developed country with a low-yield currency EUR, and Zaria is an emerging country with a high-yield currency
ZAR. All else equal, the exchange rate for ZAR will most likely appreciate if:
A) the equilibrium value of Zaria decreases over the long-term.

B) the inflation expectations in Zaria are higher relative to Skonia.
C) the nominal yield spread between Zaria and Skonia increases.
Answer C) the nominal yield spread between Zaria and Skonia increases.
Explanation C is correct. The high-yield currency’s value i.e. ZAR’s exchange rate (EUR/ZAR) will increase, if the nominal yield spread between
Zaria and Skonia rises, expected inflation in Zaria declines relative to Skonia. Section 5.2. LO.j.
44 Swiqa is a developed country that has been running a persistent current account deficit with Imoia, a developing country. The
persistent current account deficit will most likely result in:
A) Swiqa’s exchange rate depreciating over time.

B) an increase in Imoia’s trade competitiveness.
C) a decrease in Swiqa’s external debt.
Answer A) Swiqa’s exchange rate depreciating over time.
Explanation A is correct. The long-run equilibrium level of exchange rate of the country running a deficit – Swiqa, will depreciate over time. B is
incorrect because trade competitiveness of Imoia will decrease. C is incorrect because Swiqa’s external debt will increase. Section
5.1. LO.j.
45 Use this information to answer next 3 questions.

Maev, an emerging market country, is issuing high yield bonds in a bid to attract foreign investment. The booming economy has
been successful in receiving capital inflows from global funds.
In the near term, the capital inflows to Maev will least likely result in:
A) an increase in risk premia.

B) an increase in inflation expectations.
C) an increase in real currency value.
Answer A) an increase in risk premia.
Explanation A is correct. A booming economy will attract investors and in the near-term cause the risk premium to decrease. Section 5.2. LO.j.
46 Maev, an emerging market country, is issuing high yield bonds in a bid to attract foreign investment. The booming economy has
Given the excessive capital inflows, Maev’s policy makers are most likely to face which of the following situations?
A) Depreciation of the currency value.

B) Increase in property prices.
C) Limited investments in risky projects.
Answer B) Increase in property prices.
Explanation B is correct. Excessive capital inflows lead to an unwarranted appreciation of the currency value, excessive investments in risky
projects and financial asset or property market bubble. Section 5.2. LO.j.
47 Maev, an emerging market country, is issuing high yield bonds in a bid to attract foreign investment. The booming economy has
If capital inflows lead to an unwanted appreciation in the real value of its currency, Maev’s government would most likely:
A) implement capital controls.

B) liberalize fiscal policy.
C) buy its currency in foreign markets.
Answer A) implement capital controls.
Explanation A is correct. To reduce unwanted appreciation of its currency, Maev would most likely impose capital controls to counteract the
surging capital inﬂows. Section 5.2. LO.j.
Question Q-Code: L2-EC-CERD-061 LOS k Section 6
48 If capital mobility is low, an expansionary monetary policy and restrictive fiscal policy will most likely result in:
A) an ambiguous impact on exchange rate.

B) the appreciation of the domestic currency.
C) the depreciation of the domestic currency.
Answer A) an ambiguous impact on exchange rate.
Explanation A is correct. The impact on trade balance and aggregate demand is ambiguous. Section 6.1. LO.k.
49 If capital mobility is high, an expansionary fiscal policy and restrictive monetary policy will most likely result in:
A) an ambiguous impact on exchange rate.

B) an appreciation of the domestic currency.
C) a depreciation of the domestic currency.
Answer B) an appreciation of the domestic currency.
Explanation B is correct. Under high capital mobility, an expansionary fiscal policy and a restrictive monetary policy is bullish for a currency. Section
6.1. LO.k.
50 As per the Mundell-Fleming model, the factor that least likely impacts exchange rates is:
A) changes in price level.

B) interest rates.
C) aggregate demand.
Answer A) changes in price level.

Explanation A is correct. The Mundell-Fleming model helps explain changes in exchange rates brought about by changes in monetary and fiscal
policy measures. It focuses on aggregate demand, interest rates and economic activity. Section 6.1. LO.k.
51 Dhac is an example of an EM country with fixed exchange rate and expansionary monetary policy with no restrictions on capital
mobility. To maintain the exchange rate, Dhac will most likely:
A) sell its own currency against other currencies in the FX market.

B) buy its own currency in the FX market.
C) lower interest rates.
Answer B) buy its own currency in the FX market.
Explanation B is correct. A country with fixed exchange rate and expansionary monetary policy should buy its own currency in the FX market.
Lower interest rates would cause capital to flow out of the country to other countries with higher interest rates. This will cause the
currency to depreciate. Section 6.2. LO.k, l.
52 According to the monetary approach for determining exchange rates, which of the following statements is least likely correct?
A) Purchasing power parity holds at all times.

B) An increase in domestic money supply will cause an increase in domestic price level.
C) Changes in exchange rates are independent of changes in inflation rates.
Answer C) Changes in exchange rates are independent of changes in inflation rates.
Explanation C is correct. According to the monetary approach an increase/decrease in prices causes a proportional decrease/increase in
exchange rates. The monetary approach assumes that PPP holds at all times and changes in exchange rates indicate changes in
inflation rates. Section 6.2. LO.k.
53 George Kendizor is the chief economic advisor to the Government of Montenegro. David Takei is the finance secretary to the prime
minister. Montenegro is facing high inflation which has led to an appreciation in the exchange rate. They are discussing several policy
options and make the following comments:
Kendizor: As per the Mundell-Fleming model, we can arrest the appreciation of the currency using expansionary monetary policy
and restrictive fiscal policy, given that there are no restrictions on capital flows.
Takei: One of the major limitations of the pure monetary approach is the assumption that purchasing power parity holds over
both the short-term and the long-term.
Kendizor: As per the Dornbusch overshooting model, it is important to consider the impact of time period on exchange rates. As
domestic prices are inflexible in the short run, an increase in nominal money supply will cause domestic interest rates to
increase. This, in turn, will result in capital inflow and depreciation of the domestic currency in the short run.
Which of the above statements is least likely correct?
A) Kendizor’s statement on the Mundell-Fleming model.

B) Takei’s interpretation of the Taylor rule.
C) Kendizor’s interpretation of the Dornbusch overshooting model.
Answer C) Kendizor’s interpretation of the Dornbusch overshooting model.
Explanation C is correct. An increase in nominal money supply will cause domestic interest rates to decrease, which in turn will lead to capital
outflow and depreciation of the domestic currency. The other two statements are correct. Section 6.2 LO.k.
54 Dor Dor is an island nation in the French Polynesia. Dor Dor has low capital mobility and a floating exchange rate. Its currency is DRD.
The country also has an expansionary monetary policy and expansionary fiscal policy. Bor Bor is a leading hotel chain in Dor Dor that
imports all its supplies from the United States at a fixed rate (in USD) and makes all its payments in USD. In order to manage its
currency risk, which of the following actions is best recommended for Bor Bor?
A) Hedge against depreciation of the DRD.

B) Hedge against appreciation of the DRD.
C) Take no action as the exchange rate is ambiguous.
Answer A) Hedge against depreciation of the DRD.
Explanation A is correct. Hedge against depreciation of the DRD. Expansionary monetary and fiscal policy under low capital mobility conditions
cause the domestic currency to depreciate.
Section 6.1. LO.k.
Question Q-Code: L2-EC-CERD-068 LOS l Section 7
55 Which of the following is least likely a pull factor that leads to surges in capital inflows?
A) Improved current account balances.
B) Liberalization of financial markets.
C) Increased asset allocation by industrial country investors to EM countries.
Answer C) Increased asset allocation by industrial country investors to EM countries.
Explanation C is correct. This is a push factor while A & B are pull factors. Section 7 LO.l.
Question Q-Code: L2-EC-CERD-069 LOS m Section 8
56 Justin Roose is an analyst at a portfolio management firm. Roose works extensively on detection and management of currency risks.
He is currently working on an early warning system that will indicate the likelihood of a currency crisis in a country. His early warning
system will most likely indicate an imminent crisis when:
A) foreign exchange reserves show an increase.

B) the real exchange rate is higher than its mean level.
C) real economic activity is on the rise.
Answer B) the real exchange rate is higher than its mean level.
Explanation B is correct. A real exchange rate higher than its mean level during tranquil periods is a sign of an impending currency crisis. Real
economic activity shows no typical pattern leading to a crisis. Foreign exchange reserves decline sharply ahead of a crisis. Section 8.
LO.m.
Question Q-Code: L2-EC-CERD-070 LOS m Section 8
57 When developing an early warning system to predict an impending currency crisis, it would be best to:
A) exclude countries with sound economic fundamentals.

B) have a system warn market participants in advance of a crisis to allow them to hedge their portfolios.
C) include a number of key macroeconomic variables with lagged data to improve accuracy and limit false signals.
Answer B) have a system warn market participants in advance of a crisis to allow them to hedge their portfolios.
Explanation B is correct. A useful early warning system will inform market participants well in advance of an impending crisis, giving them time to
hedge their portfolios. A is incorrect because countries with sound fundamentals are also prone to currency crisis. Macroeconomic
variables with timely data instead of lagged data must be included in the early warning system, hence C is incorrect. Section 8 LO.m.

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Level II R11 Currency Exchange Rates:

Determination and Forecasting

Question Q-Code: L2-EC-CERD-014 LOS a Section 2

( USD/EUR )bid = ( USD/MXN )bid x ( MXN/EUR )bid = 0.0480 x 21.82 = 1.0474.

( USD/EUR )offer = ( USD/MXN )offer x ( MXN/EUR )offer = 0.0490 x 21.87 = 1.0716.

Section 2.1 LO.a.

Question Q-Code: L2-EC-CERD-015 LOS a Section 2

( PHP/MXN )offer = ( PHP/EUR )offer x ( EUR/MXN )offer = (1/0.018) x 0.8584 = 47.6927

Section 2.1. LO.a.

Question Q-Code: L2-EC-CERD-016 LOS b Section 2

A dealer quotes a bid-offer rate of 0.6460/0.6490 in INR/PKR.

Oglivy’s steps for a triangular arbitrage would most likely involve:

Step 1: Calculate the interbank implied cross rate for INR/PKR.

( INR/PKR )bid = ( INR/USD )bid x ( USD/PKR )bid = 68.2210 x 1/104.9500 = 0.6500.

( INR/PKR )offer = ( INR/USD )offer x ( USD/PKR )offer = 68.2450 x 1/104.7500 = 0.6515.

Question Q-Code: L2-EC-CERD-017 LOS b Section 2

A) there is no arbitrage opportunity.

Answer A) there is no arbitrage opportunity.

Question Q-Code: L2-EC-CERD-018 LOS a Section 2

Question Q-Code: L2-EC-CERD-019 LOS b Section 2

Answer B) AUD 0.002.

AUD/EUR bid = AUD/GBP bid x GBP/EUR bid = 1.6770 x (1/1.1597) = 1.4461

AUD/EUR offer = AUD/GBP offer x GBP/EUR offer = 1.6778 x (1/1.1592) = 1.4474

profit from the transaction = 1.4461 – 1.4440 = AUD 0.0021

Section 2.1 LO.b.

Question Q-Code: L2-EC-CERD-020 LOS b Section 2

Country Currency Spot Exchange Rate **

Hong Kong HKD NA

New Zealand NZD 0.1800 / 0.1900

** Number of foreign currency units per one HKD

Answer A) HKD 291,193.

Sell NZD to the dealer at 78.45 = 18000,000 x 78.45 = JPY1,412,100,000.

Sell JPY in the interbank market at 14.08 = 1,412,100,000/14.08 = HKD100,291,193.

Hence profit = HKD(100,291,193-100,000,000) = HKD291,193. Section 2.1 LO.b.

Question Q-Code: L2-EC-CERD-021 LOS b Section 2

Currency pair Spot rate

SEK / EUR 9.8100 9.8300

GBP / EUR 0.8581 0.8585

GBP / SEK 0.0881 0.0892

Step 1: Calculate the interbank implied cross rate for GBP/SEK.

GBP/SEK bid = GBP/EUR bid x EUR/SEK bid = 0.8581 x 1/9.8300 = 0.0873.

GBP/SEK offer = GBP/EUR offer x EUR/SEK offer = 0.8585 x 1/9.8100 = 0.0875.

Section 2.1. LO.b.

Question Q-Code: L2-EC-CERD-022 LOS c Section 2

180-day Libor (NZD): 3.21%

180-day Libor (AUD): 2.83%

F = 0.95 x (1+ 0.0283 x 180/360) / (1 + 0.0321 x 180/360) = 0.95 x (1.01415)/(1.01605) = 0.9482.

Calculate the forward premium (discount) = F – S = 0.9482-0.9500 = -0.0018

Section 2.2. LO.c.

Question Q-Code: L2-EC-CERD-023 LOS c Section 2

Country Currency Pair Spot rate 1-year interest

Cruxia CRX / USD 51.0200 8.2 %

Canada CAD / USD 1.3427 0.5 %

United States NA NA 0.25%

Step 1: Determine the CRX/CAD cross rate.

CRX/CAD = CRX/USD x USD/CAD = 51.0200 x (1/1.3427) = 37.9981 = 38.0000 approx.

Question Q-Code: L2-EC-CERD-024 LOS d Section 2

11 The information below relates to next 3 question

Spot rate (USD/EUR)1.0619/1.0620

One month 13.01/13.04

Two month 33.1/33.4

Three month 49.1/49.4

Four month 62.8/63.4