Foreign exchange market MCQ Quiz in বাংলা - Objective Question with Answer for Foreign exchange market - বিনামূল্যে ডাউনলোড করুন [PDF]

The correct answer is Foreign Exchange Risk.

Key Points

• Foreign exchange risk arises when a company engages in financial transactions denominated in a currency other than the currency where that company is based.
• Any appreciation/depreciation of the base currency or the depreciation/appreciation of the denominated currency will affect the cash flows emanating from that transaction.
• Foreign exchange risk can also affect investors, who trade in international markets, and businesses engaged in the import/export of products or services to multiple countries.
• There are three types of foreign exchange risk:
  • Transaction risk
  • Translation risk
  • Economic Risk

Additional Information

There are three types of foreign exchange risk:

1. Transaction risk: This is the risk that a company faces when it's buying a product from a company located in another country. The price of the product will be denominated in the selling company's currency. If the selling company's currency were to appreciate versus the buying company's currency then the company doing the buying will have to make a larger payment in its base currency to meet the contracted price.
2. Translation risk: A parent company owning a subsidiary in another country could face losses when the subsidiary's financial statements, which will be denominated in that country's currency, have to be translated back to the parent company's currency.
3. Economic risk: Also called forecast risk, refers to when a company’s market value is continuously impacted by unavoidable exposure to currency fluctuations.

The correct answer is 1, 2 and 3.

Key Points

• The Forex Reserves (foreign exchange reserves) of an economy is its ‘foreign currency assets’ added with its gold reserves, SDRs (Special Drawing Rights) and Reserve Tranche Position (RTP) in the IMF. In a sense, the Forex reserves are the upper limit up to which an economy can manage foreign currency in normal times if need be.
• India's forex reserves comprise foreign currency assets (FCAs), gold reserves, special drawing rights (SDRs), and the country's reserve position with the International Monetary Fund (IMF).
• Foreign exchange reserves reached an all-time high of US$ 583.8 billion as of February 19, 2021, covering about 18 months of imports. At present, India is the fifth-largest foreign exchange reserves holder among all countries of the world after China, Japan, Switzerland and Russia.
  • Hence, statement 1 is not correct.
• Foreign Currency Assets (US$ 542.1 billion) constitute the largest component of the forex reserves followed by Gold (US$ 35.2 billion) and Special Drawing Rights (US$ 1.5 billion).
  • Hence, statement 2 is not correct.
• The Reserve Bank of India Act, 1934 provides the overarching legal framework for the deployment of reserves in different foreign currency assets and gold within the broad parameters of currencies, instruments, issuers and counterparties. In brief, the law broadly permits the following investment
• Categories:
  • Deposits with other central banks and the Bank for International Settlements (BIS);
  • Deposits with commercial banks overseas;
  • Debt instruments representing sovereign/sovereign-guaranteed liability with residual maturity for the debt papers not exceeding 10 years;
  • Other instruments/institutions as approved by the Central Board of the Reserve Bank.
    • Hence statement 3 is not correct.

The correct answer is Revaluation.

Key Points The increase in the value of a country's foreign exchange rate which is done intentionally by the government is called revaluation.

• Revaluation: This refers to the deliberate upward adjustment of a country's official exchange rate relative to a chosen baseline, such as another currency, a basket of currencies, or gold. It means your domestic currency becomes more valuable compared to foreign currencies.
• Government intervention: Revaluation is usually done by the government or central bank through policies like buying foreign currency in the open market, raising interest rates, or intervening directly in the exchange rate market.
• Intentional increase: Unlike depreciation, which occurs when a currency loses value naturally due to market forces, revaluation is a deliberate action taken by the government to strengthen the exchange rate.

Additional Information Here are some reasons why a government might choose to revalue its currency:

• To reduce inflation: By making imports cheaper, revaluation can help to lower domestic price levels and reduce inflation.
• To improve exports: A stronger currency makes exports more expensive for foreign buyers, potentially leading to a decline in exports. However, it can also make exporting firms more competitive by lowering their production costs in terms of foreign currency.
• To protect domestic industries: Revaluation can shield domestic industries from competition from foreign imports by making them more expensive.
• To increase foreign investment: A stronger currency can make a country more attractive to foreign investors by offering a higher return on their investment.

The correct answer is Both (A) and (R) are true and (R) is the correct explanation of (A).

Key PointsBalance of payments (BOP):

• The balance of payments (BOP) is the record of all international financial transactions made by the residents of a country.
• There are three main categories of the BOP: the current account, the capital account, and the financial account.
• The current account is used to mark the inflow and outflow of goods and services into a country.
• The capital account is where all international capital transfers are recorded.
• In the financial account, international monetary flows related to investment in the business, real estate, bonds, and stocks are documented.

Current account:

• The current account measures a country's imports and exports of goods and services over a defined period of time, in addition to earnings from cross-border investments and transfer payments.
• Exports, earnings on investments abroad, and incoming transfer payments (aid and remittances) are recorded as credits; imports, foreign investors' earnings on investments in the country, and outgoing transfer payments are recorded as debits.
• When credits exceed debits, the country enjoys a current account surplus, meaning that the rest of the world is in effect borrowing from it.
• A current account surplus increases a nation's net assets by the amount of the surplus.

Important Points 

Current account surplus:

• Current account surpluses refer to positive current account balances, meaning that a country has more exports than imports of goods and services.
• Countries with consistent current account surpluses face upward pressure on their currency.
• Current account surpluses can also indicate low domestic demand or maybe the result of a drop in imports due to a recession.
• Sustained current account surplus encourages the government to liberalize imports and capital movements.
• Thus, Assertion (A) is true. 
• Also the position of current account and BOP is likely to influence the economic and trade policies of the government. 
• Thus, Reason R is also true. 
• And (R) is the correct explanation of (A).

Hence, the correct answer is Both (A) and (R) are true and (R) is the correct explanation of (A).

The correct answer is C and E only.

Key PointsCurrency Depreciation

• In a floating rate system, the exchange value of a nation's currency in relation to other currencies is referred to as currency depreciation.
• Based on trade imports and exports for a certain nation, the depreciation rate of a currency is calculated.
• Demand for imported goods drives up imports, which boosts foreign currency investment and weakens home currencies.

Important PointsCauses of Currency Depreciation

1. A fall in the world price of a country's major export. This leads to a decline in export revenues and a fall in overseas demand for the exporting nation's currency
2. There is a surge in the value of imports causing a deficit on the current account of the balance of payments which then leads to a net outflow of currency, causing exchange rate weakness.
3. A country's central bank reduces interest rates, leading to a net outflow of hot money(Portfolio outflow) - this is short term financial capital that searches for the best risk-adjusted rate of return
4. Depreciation might be caused by intervention from the Central Bank e.g. it goes into the market to sell their own currency and buy gold and foreign currencies.
5. The basic trend analysis of the variables show that; for countries that suffers from high original sin, a depreciation in currency is accompanied by rising external indebtedness and/or high debt servicing costs.

Hence, it can be concluded that currency depreciation in the Indian Rupee in recent times has largely been attributed to only option C and E only.

The correct answer is A - 1, B - 2, C - 4, and D - 3.

Important Points

Hence, it can be concluded that the correct options are  A-1, B-2, C-4, and D-3.

The correct answer is Director General of Foreign Trade (DGFT)

Important Points

•  The Director General of Foreign Trade (DGFT) organisation is an attached office of the ministry of commerce and industry and is headed by DGFT.
• Headquarters are in New Delhi and is responsible for formulating and implementing foreign trade policy and thus responsible for the execution of India's import-export policies.

​Hence The correct answer is Director General of Foreign Trade (DGFT).

Additional Information

•  Chief Controller of Imports and Exports: Chief Controller of Imports and Exports is a government regulatory department of Bangladesh concerning export and import and is located in Dhaka.
• Federation of Indian Export Organisations: Federation of Indian Export Organisations is the trade promotion organisation in India set up by the Ministry of Commerce, the Government of India, and the private trade and industry segment in 1965. It is responsible for representing and assisting Indian entrepreneurs in foreign markets. 
•  Export Promotion Councils and Commodity Boards:

1.  Export promotion Councils are registered as non-profit organizations under the Companies Act. These councils promote and support export firms in developing their foreign trade.
2. Commodity boards are established by the government of India to promote traditional commodities that have high export potential.

The correct answer is (A) , (B) and (D) only.

Key Points Foreign Exchange Risk

Foreign exchange risk refers to the risk that a business’s financial performance or financial position will be affected by changes in the exchange rates between currencies.

Important Points

•  Transaction risk

Transaction risk is the risk faced by a company when making financial transactions between jurisdictions. The risk is the change in the exchange rate before transaction settlement. 

• Economic Risk

Economic risk, also known as forecast risk, is the risk that a company’s market value is impacted by unavoidable exposure to exchange rate fluctuations. Such a type of risk is usually created by macroeconomic conditions such as geopolitical instability and/or government regulations.

• Currency Risk

Currency exposure is a term referring to the vulnerability of an investment, cash flow, or financial position to variations in the exchange rate of two currencies.

Additional Information Translation Risk- Translation risk, also known as translation exposure, refers to the risk faced by a company headquartered domestically but conducting business in a foreign jurisdiction, and of which the company’s financial performance is denoted in its domestic currency.

Hence, the correct answer is (A) , (B) and (D) only.

Exchange Rate refers to the price of one currency in terms of another currency.

Arbitrageurs:

• Arbitrage is a process where investors/arbitrageurs are looking to make a riskless profit out of the difference between the interest rate and the forward discount and the forward premium.
• The participants/arbitrageurs take advantage of the different exchange rates in different markets by purchasing an asset from a low-price market and selling it in the higher price market.
• It leads to the equalization of prices of assets in all segments of the market.

Therefore, the participants who take advantage of different exchange rates in different markets are Arbitrageurs.

Speculators:

• Speculators are agents who speculate the market and then make a decision to purchase or sell the foreign exchange with the intention of making a profit by taking advantage of changes in exchange rates.
• They participate in forward exchange market by entering into forward exchange deal.

Hedgers:

• These are participants who enter into forward exchange market to protect themselves against the risk arising out of the fluctuations in the exchange rate.
• It is especially essential for those firms which have large amounts of receivables or commitments to pay in foreign currencies.

Investors:

• An investor is any person or entity that allocates capital with the expectation that in the future he will gain financial returns from it.
• Investors play a vital role in the growth of a company.

The correct answer is Purchasing power parity theory

Key PointsPurchasing Power Parity Theory:

• Purchasing-power parity is a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries.
• The purchasing-power parity theory is the simplest and most widely accepted theory explaining the variation of currency exchange rates.
• The theory of purchasing-power parity is based in principle called the law of one price.
• When the central bank prints large quantities of money, the money loses value both in terms of the goods and services it can buy and in terms of the amount of other currencies it can buy.

Additional Information 1. The Fisher Effect:

• The Fisher Effect states that nominal interest rates (r) are a function of the real interest rate (a) and a premium (i) for inflation expectations.  R = a + i
• Real Rates of Interest (i) Should tend toward equality everywhere through arbitrage  (ii) With no government interference, nominal rates vary by inflation differential.
• According to the Fisher Effect, countries with higher inflation rates have higher interest rates.
• Due to capital market integration globally, interest rate differentials are eroding.

2. Mint Parity Theory:

• The theory of mint parity describes how the exchange rate between the two gold standard countries is determined.
• The currency of a country on the gold standard is either manufactured of gold or has its value stated in gold.
• The exchange rate under the gold standard is equivalent to the gold content of one currency relative to another, according to the mint parity theory. This rate is referred to as the mint rate.

3. Interest rate parity theory:

• One of the most important theories in international finance is interest rate parity, which is the best approach to explain how exchange rate values are determined and why they fluctuate. Understanding the primary motivations for foreign investment is crucial because the majority of international currency exchanges occur for investment purposes.
• Interest rate parity is a condition in which the rates of return on equivalent assets in two countries are equal. On the basis of how it is described here, the term is a misleading term; it should really be called rate of return parity.

4. Balance of Payment theory

• The free forces of demand and supply in the foreign currency market determine the price of foreign money in terms of domestic money, according to the balance of payments theory of exchange rate.
• As a result, the demand for and supply of a country's currency will determine the currency's external value.
• According to the theory, a balance of payments deficit causes the rate of exchange to decrease or depreciate, whereas a surplus strengthens the exchange reserves, causing the price of the home currency to appreciate in terms of foreign currency.