Financial Institutions and Markets
Assignment- Week 12
TYPE OF QUESTION: MCQ/MSQ
Number of questions: 20 Total mark: 20 X 1 = 20
QUESTION 1:
Real Effective Exchange Rate is a weighted average of the bilateral nominal exchange rate of
the home currency against selected foreign currencies. State whether the statement is True or
False.
A. True
B. False
Correct Answer: B. False
Detailed Solution:
Nominal Effective Exchange Rate is a weighted average of the bilateral nominal exchange rate
of the home currency against selected foreign currencies.
QUESTION 2:
In India, the cross-reference refers to the relationship between two non-rupee currencies. State
whether the statement is True or False.
A. True
B. False
Correct Answer: A. True
Detailed Solution:
In India, the cross-reference refers to the relationship between two non-rupee currencies.
QUESTION 3:
________ can be defined as capitalizing on a discrepancy in quoted price to make a riskless
profit.
A. Hedging
B. Portfolio
C. Arbitrage
D. Derivatives
Correct Answer: C. Arbitrage
Detailed Solution:
Arbitrage can be defined as capitalizing on a discrepancy in quoted prices to make a riskless
profit.
QUESTION 4:
Locational Arbitrage is possible when a bank’s bid price is lower than another bank’s ask price
for the same currency. State whether the statement is True or False.
A. True
B. False
Correct Answer: B. False
Detailed Solution:
Locational Arbitrage is possible when a bank’s bid price is higher than another bank’s ask price
for the same currency.
QUESTION 5:
$1= 140 rupees; £1=196 Rupees; £1=$1.4; Peter has 1400 Rupees and wants to convert it to
pounds sterling.
Using the above information, which of the following statements is/are true?
A. Locational Arbitrage is possible
B. Locational Arbitrage is not possible
C. Triangular Arbitrage is possible
D. Triangular Arbitrage is not possible
Correct Answer: D. Triangular Arbitrage is not possible
Detailed Solution:
Triangular arbitrage is possible when a cross-exchange rate quote differs from the rate
calculated from spot rate quotes. Locational arbitrage is possible when a bank’s buying price
(bid price) is higher than another bank’s selling price (ask price) for the same currency.
Suppose Peter has 1400 Rupees and wants to convert it to Pound sterling.
Direct Method:
Rupees to Pound Sterling: 1400/196 =£ 7.14
Indirect Methods:
Rupees to Dollar: 1400/140 =$10
Dollar to Pound Sterling: 10/1.4 =£7.14
Since both methods of conversion lead to the same value, arbitrage is not possible.
QUESTION 6:
When the purchase or sale of foreign currency is offset by a corresponding sale or purchase of
domestic government debt, how does it eliminate the effects on the domestic money supply?
A. Sterilized intervention
B. Non-Sterilized intervention
C. Rapid intervention
D. Arbitrage
Correct Answer: A. Sterilized intervention
Detailed Solution:
Sterilized intervention occurs when the purchase or sale of foreign currency is offset by a
corresponding sale or purchase of domestic government debt to eliminate the effects on the
domestic money supply.
QUESTION 7:
Nominal Effective Exchange Rate index (NEER) = 118, domestic inflation = 9%, foreign
inflation = 4%. Compute the real effective exchange rate (REER).
A. 113
B. 130
C. 110
D. 118
Correct Answer: A. 113
Detailed Solution:
REER = Nominal Effective Exchange Rate index X ((1+foreign inflation)/(1+ Domestic
inflation) = 118 X 0.954 = 113
QUESTION 8:
_______ set up a new company “from the ground up” in the foreign country.
A. Greenfield Investments
B. Acquisitions
C. Wholly owned Subsidiary
D. Joint Ventures
Correct Answer: A. Greenfield Investments
Detailed Solution:
Greenfield Investments – set up a new company “from the ground up” in a foreign country.
Example: Motorola invests money in China and builds a new plant to produce cell phones.
QUESTION 9:
A dealer provides the following quotes:
Ratio
INR/USD 0.800
INR/EUR 0.950
INR/NZD 1.050
Using the above information, calculate the EUR/USD cross rate.
A. 0.842
B. 0.500
C. 0.950
D. 0.750
Correct Answer: A. 0.842
Detailed Solution:
EUR/USD=(INR/EUR)-1*INR/USD = (1/0.950) X0.800 = 0.842
QUESTION 10:
Sub-account refers to any person who is resident outside India, on whose behalf investments
are proposed to be made in India by a foreign institutional investor, and who is registered as a
sub-account under the SEBI (FII) Regulations, 1995. State whether the statement is True or
False.
A. True
B. False
Correct Answer: A. True
Detailed Solution:
Sub-account refers to any person who is resident outside India, on whose behalf investments
are proposed to be made in India by a foreign institutional investor, and who is registered as a
sub-account under the SEBI (FII) Regulations, 1995.
QUESTION 11:
A _____ quotation expresses foreign currency per unit of domestic currency.
A. Direct quote
B. Indirect quote
C. Cross exchange rate
D. Forward rate
Correct Answer: B. Indirect quote
Detailed Solution:
Indirect quotation shows how much foreign currency equals one unit of domestic currency.
QUESTION 12:
The primary objective of central bank intervention in the foreign exchange market is?
A. To develop a monopoly
B. Reduce imports
C. To increase the money supply
D. Reduce excess exchange rate volatility
Correct Answer: D. Reduce excess exchange rate volatility
Detailed Solution:
The primary objective of central bank intervention in the Foreign exchange market is : (1) to
influence trend movements in the exchange rates because they perceive long-run equilibrium
values to be different from actual values, (2) to maintain export competitiveness, (3) To manage
volatility to reduce risks in financial markets, (4) To protect currency from speculative attacks
and crisis.
QUESTION 13:
Foreign Direct Investments are short-term investments, whereas foreign institutional
investments are long-term investments. State whether the statement is True or False.
A. True
B. False
Correct Answer: B. False
Detailed Solution:
Foreign Direct Investments are long-term investments, whereas foreign institutional
investments are short-term investments.
QUESTION 14:
The exchange rate between the two currencies has increased to 2.2500. If the base currency has
appreciated by 10 percent against the price currency, the initial exchange rate between the two
currencies was closest to:
A. 2.0455
B. 2.5000
C. 2.7500
D. 2.2900
Correct Answer: A. 2.0455
Detailed Solution:
The percentage appreciation of the base currency can be calculated by dividing the
appreciated exchange rate by the initial exchange rate. In this case, the unknown is the initial
exchange rate. The initial exchange is the value of x that satisfies the formula: 2.2500/x =1.10
X=2.2500/1.10 = 2.0455
QUESTION 15:
If the one-year US nominal interest rate is 5%, the one-year Indian nominal interest rate is 11%,
and the current spot exchange rate, S0, is ₹90/$ then the expected spot rate in one year will be
₹_____
A. 95.143
B. 90
C. 98
D. 92
Correct Answer: A. 95.143
Detailed Solution:
S1 =(1.11/1.05)*90 = 95.143
QUESTION 16:
The 90-day interest rate is 1.10% in the US and 2.25%in the UK, and the current spot rate
exchange rate is $1.75/£. What will be the 90-day forward rate?
A. 1.7304
B. 1.1500
C. 1.9800
D. 2.000
Correct Answer: A. 1.7304
Detailed Solution:
(F – S)/S = [(1+iH)/ (1+iF)] -1= (iH–iF)/ (1+iF)
(F-1.75)/1.75 = [(1.0110)/(1.0225)]-1
F= 1.7304
QUESTION 17:
The Fisher Effect is the relationship between the nominal exchange rate, the inflation rate, and
the strike price. State whether the statement is True or False.
A. True
B. False
Correct Answer: B. False
Detailed Solution:
The Fisher Effect is the relationship between the nominal interest rate, the inflation rate, and
the real interest rate.
Real interest rate = Nominal interest rate – Inflation rate
QUESTION 18:
A relatively high interest rate may reflect expectations of relatively low inflation, which
discourages foreign investment. State whether the statement is True or False.
A. True
B. False
Correct Answer: B. False
Detailed Solution:
A relatively high interest rate may reflect expectations of relatively high inflation, which
discourages foreign investment
QUESTION 19:
Banks charge their customers more than the interbank selling or ask rate and pay their
customers less than the interbank or bid rate. State whether the statement is True or False.
A. True
B. False
Correct Answer: A. True
Detailed Solution:
Banks charge their customers more than the interbank selling or ask rate and pay their
customers less than the interbank or bid rate.
QUESTION 20:
Which among the following belongs to category II of AD?
A. Selected Regional Rural Banks
B. Public Sector Banks
C. EXIM Bank
D. Foreign Banks
Correct Answer: A. Selected Regional Rural Banks
Detailed Solution:
All scheduled commercial banks, which include public sector banks, private sector banks, and
foreign banks operating in India, belong to category I of ADs. All upgraded full-fledged money
changers (FFMCs) and select regional rural banks (RRBs) and co-operative banks belong to
category II of ADs. Selected financial institutions, such as EXIM Bank, belong to category III
of ADs.