Solutions Paper - Eco

CFA LEVEL - 1 MOCK PAPER
8TH JULY 18 (SOLUTIONS)
Time:- 45 Min. Marks:- 30
ECO-CURRENCY RATE
1. A is correct. In case of an exchange rate quote of 1.5062 USD/EUR, USD is the price currency
and EUR is the base currency. 1 EUR equals to 1.5062 USD.
2. B is correct. Here EUR is the base currency. The real exchange rate = nominal exchange rate *
price level in EUR / price level in USD. Assume that initially the nominal exchange rate = 1, the
price level in EUR = 1 and the price level in USD = 1. Hence the real exchange rate = 1. After
the changes the real exchange rate = [(1 + 0.072) * (1 – 0.03)] / (1 + 0.02) = 1.0194. This
represents a change of 1.94% relative to the initial value of 1.
3. B is correct. To reduce its foreign exchange risk, the US firm will initiate a forward contract to
sell JPY at an exchange rate agreed today.
4. B is correct.
Real exchange rate = Nominal spot exchange rate * CPI of the foreign country / CPI of the
domestic country
As the domestic price level decreases, the real exchange rate increases.
5. A is correct. Real exchange rate

 CPI foreign 
  No min al exchange rate    
 CPIdomestic 
 105 
 65     62.61
 109 
6. C is correct. Multinational banks are sell side market participants.
7. C is correct. The receivable is due in 200 days. To reduce the risk of currency exposure, the
Chinese company would initiate a forward contract to sell dollars at an exchange rate agreed to
today.
8. A is correct. Exchange rate risk is defined by the uncertainty over future spot rates.
9. C is correct. The correct statement is ‘The central bank intervenes in the FX market when the
domestic currency becomes so strong that it undercuts the country’s export competitiveness’.
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10. B is correct. Statement I and III are correct. Statement II is incorrect because forward contracts
can be of any size and settlement date that the two counterparties agree upon.
11. B is correct. A decrease in the USD/EUR exchange rate represents a depreciation of the EUR by
1.42/1.44 -1 = -0.0139.
12. A is correct.
CPI b 101
Re al Exchange Rate   Spot rate p/b   28   26.18
CPI p 108
13. A is correct. In the case of a direct exchange rate, the domestic currency is the price currency
(the numerator) and the foreign currency is the base currency (the denominator). If the domestic
currency depreciates, then the exchange rate (domestic per foreign) increases.
14. B is correct. The direct exchange rate quotation uses the domestic currency as the price currency
and the foreign currency as the base currency. So, for a UK client a direct quote will have USD
as the base currency and GBP as the price currency.
15. B is correct. The IND/PKR bid is the reciprocal of the PKR/IND offer: 1/1.1236 = 0.8900. The
IND/PKR offer is the reciprocal of the PKR/IND bid: 1/1.1228 = 0.8906. Note that the bid
always has to be lower than the offer.
16. B is correct.
EUR
CAD  USD  GBP
 
GBP  EUR  CAD
CAD 1.174
Spot rate of  1.285   1.344
GBP 1.122
CAD 1.168
Expected spot rate of  1.275   1.305
GBP 1.141
1.305
The expected depreciation of the GBP relative to CAD   1  2.90%
1.344
17. A is correct. MXN/EUR = MXN/USD * USD/EUR = 12.3 * 1.45 = 17.83.
18. B is correct.
USD USD MXN 1
    2.1097  1.0104
GBP MXN GBP 2.0880
19. B is correct. The forward exchange rate is 1.3047 + 26.8 / 10,000 = 1.3074.
20. C is correct. The forward exchange rate is 1.3047 (1 + 0.01576) = 1.3253.
21. C is correct. As the spot USD/GBP exchange rate decreases, USD appreciates against the GBP,
the purchasing power of a US client increases, and the real USD/GBP exchange rate reduces.

22. C is correct. Forward rate
1  i price currency
 Spot rate 
1  i base currency
90
1  0.0014 
 81.31  360
90
1  0.0484 
360
1.00035
 81.31   80.37
1.0121
23. A is correct. The base currency will trade at a forward premium if the interest rate in the price
currency is higher than the interest rate in the base currency.
24. B is correct. The base currency will trade at a forward discount if the interest rate in the base
currency is higher than the interest rate in the price currency.
25. C is correct. The base currency is said to be trading at a forward premium if it is the currency
with the lower interest rate.
26. A is correct. Covered interest arbitrage will ensure identical terminal values by investing the
same initial amounts at the respective country’s domestic interest rates:
 180 
GBP investment: £2.1986   1  0.015051    £2.2151
 360 
 180 
NZD investment: NZ$1   1  0.038085    NZ$1.0190
 360 
The forward rate is determined by equating these two terminal amounts:
£2.2151
GBP/NZD forward Rate   £2.1738 / NZ$
NZ$1.0190
Forward points = (Forward – Spot) * 10,000 = (2.1738– 2.1986) * 10,000 = –248.0.
27. C is correct. A is incorrect because it is the currency board system (not dollarization) where the
monetary authority can earn a profit by paying little or no interest on its liability while paying a
market rate on its assets. B is incorrect because a target zone regime has a fixed parity with
horizontal intervention bands.
28. A is correct. If the Marshall-Lerner condition is satisfied, a depreciation of the domestic

currency will reduce an existing trade deficit.
ω X ε X  ωM  ε M  1   0
 250   300 
   0.7     0.1  0.318  0.054  0.264  0
 550   550 
29. A is correct. The J-curve effect refers to the fact that depreciation of the domestic currency may
increase a trade deficit in the short run even though it will eventually reduce the trade deficit.

30. C is correct. In a CBS, the monetary authority has an obligation to maintain 100% foreign
currency reserves against the monetary base. It thus cannot lend to troubled financial
institutions.

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CFA LEVEL - 1 MOCK PAPER

8TH JULY 18 (SOLUTIONS)

Time:- 45 Min. Marks:- 30

5. A is correct. Real exchange rate

6. C is correct. Multinational banks are sell side market participants.

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 1

17. A is correct. MXN/EUR = MXN/USD * USD/EUR = 12.3 * 1.45 = 17.83.

20. C is correct. The forward exchange rate is 1.3047 (1 + 0.01576) = 1.3253.

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28. A is correct. If the Marshall-Lerner condition is satisfied, a depreciation of the domestic

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SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 4

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