Foreign Exchange Certification Quiz: Trivia!

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Foreign Exchange Certification Quiz: Trivia! - Quiz

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Questions and Answers
  • 1. 

    A US-based client with receivables in EUR says he believes the EUR/USD rate will move up but that he must hedge the exposure. As an alternative to a forward you suggest, he considers using a Forward Extra.  You explain this is because:

    • A.

      The forward extra will still give him protection at the Forward Rate but allow him to benefit should EUR/USD in fact move in his favour

    • B.

      The forward extra will give him protection at slightly worse rate than the Forward but potentially allow him to benefit from a significant move of EUR/USD in his favour

    • C.

      Give him protection at a slightly better rate than the forward rate and allow him to benefit from a EUR/USD move in his favour

    Correct Answer
    B. The forward extra will give him protection at slightly worse rate than the Forward but potentially allow him to benefit from a significant move of EUR/USD in his favour
    Explanation
    The forward extra involves buying a vanilla option, to get guaranteed protection, and selling a reverse knock-in option. The customer usually enters into the forward extra at zero cost. The sold option also referred to as the 'funding leg', is not wanted by the customer since they will potentially suffer if it is 'knocked in', but is used to make the structure zero cost. Both options have the same strike (creating a kind of synthetic forward). There are pros and cons from the hedger's perspective compared to just entering into the basic forward - the pro is that the commitment to transact only exists if the funding leg is knocked in and the con is that the structure carries a forward rate worse than regular/vanilla forward rate.

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  • 2. 

    You are pricing up a zero cost participating forward on USD/CHF to enable you to sell USD.  The 1-year forward rate for USD/CHF is currently 0.91.  The Notional on the put leg is 10m and on the call leg is 20m. Will the forward rate for this structure be higher or lower than the relevant one-year forward rate?

    • A.

      It will be lower

    • B.

      It will be higher

    • C.

      It is impossible to say as it depends on the level of implied volatility

    Correct Answer
    B. It will be higher
    Explanation
    The forward rate for this structure will be higher because the notional on the call leg is greater than the notional on the put leg. This means that there is a larger amount of USD being sold in the forward contract, which would result in a higher forward rate compared to the 1-year forward rate for USD/CHF.

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  • 3. 

    An investor seeks a better return than the risk-free rate and is offered a DCD by his bank. He is a little confused about this type of deposit. You explain to him that:

    • A.

      This is a capital-protected investment since the investor deposits money and buys an option. However the coupon is conditional on spot reaching a ceratin level

    • B.

      This is not a capital-protected investment since the investor deposits money and sells an option. In any case the coupon is conditional on spot reaching a ceratin level

    • C.

      This is a capital-protected investment since the investor deposits money and buys an option. In any case, the coupon is guaranteed.

    • D.

      This is not a capital-protected investment since the investor deposits money and sells an option. In any case, the coupon is guaranteed.

    Correct Answer
    D. This is not a capital-protected investment since the investor deposits money and sells an option. In any case, the coupon is guaranteed.
    Explanation
    In the DCD, the customer deposits a sum of money in one currency and simultaneously writes i.e. sells a call option on that deposit. If the call option is exercised, by definition, as the writer of the option, the investor, therefore, incur a loss. The premium received from writing the option is used to supplement the interest earned on the deposit and gives the investor an 'enhanced yield' i.e. enhanced over and above the basic deposit rate.

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  • 4. 

    Which of the following best describes the theoretical value (TV) shown for any vanilla option:

    • A.

      The price achieved by plugging the historical volatility into Black and Scholes formula

    • B.

      The price achieved by plugging the market volatility into Black and Scholes formula

    • C.

      The price achieved by plugging the ‘at the money’ volatility into Black and Scholes formula

    Correct Answer
    C. The price achieved by plugging the ‘at the money’ volatility into Black and Scholes formula
    Explanation
    The fact to learn. Understand though that for a vanilla option, if you know the price, you can calculate the volatility needed to plug into BS in order to arrive at that price - this is the 'implied' vol.

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  • 5. 

    You are attempting to sell a customer a 1 year GBP/USD forward extra to enable him to buy GBP with a forward rate of 1.5500. The knock-in trigger on the put leg would be set at 1.4000. The customer is concerned with spot hitting the trigger level.  Which SD feature would be relevant to use in this case?

    • A.

      Run the pricing table on this structure

    • B.

      Backtest a 1 year one touch with a trigger at 1.4

    • C.

      Check whether the one year forward rate is above or below 1.4

    • D.

      Backtest the forward extra you have priced

    Correct Answer
    B. Backtest a 1 year one touch with a trigger at 1.4
    Explanation
    The forward extra contains a US style barrier i.e.a barrier that can be touched at any time. In order to see if this barrier would have been touched in the past, we can therefore backtest a one touch.

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  • 6. 

    Discussing the functionalities of the Risk Matrix features with a middle office prospect that monitors an FX portfolio of 10 different currency pairs, you explain to him that a key benefit to him would be the ability to...

    • A.

      Compare the performance of his portfolio to the performance of forwards

    • B.

      Show the worse case scenario for his entire portfolio with a confidence level of 95%

    • C.

      Assess potential losses on his position based on simultaneous shifts of spot and volatility

    • D.

      View a matrix of the influence of spot, time and interest rate changes on his portfolio

    Correct Answer
    C. Assess potential losses on his position based on simultaneous shifts of spot and volatility
    Explanation
    In some territories, there is an accounting requirement to show the worst-case scenario from different shifts in volatility and spot. This can also be the basis for some risk managers to calculate collateral positions and margin calls for customers i.e. how much money should be posted and when by customers to cover the risk of potential future losses.

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  • 7. 

    A sales person in a bank uses SD's Find Strategy tool to look for a ZERO COST strategy. Which of the following strategies will not be suggested by the system?

    • A.

      Risk Reversal

    • B.

      Participating Forward

    • C.

      Forward Extra

    • D.

      Straddle

    Correct Answer
    D. Straddle
    Explanation
    All of the above mentioned strategies except for the KO put can be structured as zero cost. KO put cannot be a zero-cost structure in isolation, as it just means buying a single option, so it can not be free.

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  • 8. 

    Before showing the system to a new prospect at a bank, he tells you that he typically uses vanillas and occasionally barrier options.  He tells you that in the current climate, clients have stopped using leverage to enhance the performance of hedges. What does he mean by leverage in this context?

    • A.

      Using digital options, with binary payouts, in order to improve the strike attached to the protection leg of strategies.

    • B.

      Options have leveraged payoffs, which by definition, offer the client potential protection levels at preferable rates to simply forwards.

    • C.

      Creating strategies where the sell (funding leg) has a greater notional than the buy (protection leg) in order to achieve more attractive strike levels.

    Correct Answer
    C. Creating strategies where the sell (funding leg) has a greater notional than the buy (protection leg) in order to achieve more attractive strike levels.
    Explanation
    A participating forward is a typical leveraged strategy. Placing a higher notional on the 'funding leg' i.e. the sell leg, allows the bank/customer to create a zero cost structure with a preferable forward rate.

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  • 9. 

    A US-based company with 10m Euro worth of sales enters into a forward extra with a forward rate of $1.25 and a barrier of $1.50 (given the underlying forward rate of $1.30). Which is the best-case scenario for the company from the following scenarios?

    • A.

      The market finishes at $1.20 and they exercise their option when it is ITM and sell at $1.30.

    • B.

      The market rises to $1.45 on expiry without touching $1.50 and the company has no obligation from the forward extra.

    • C.

      The market rises to $1.60 and finishes at $1.49 on expiry.

    Correct Answer
    B. The market rises to $1.45 on expiry without touching $1.50 and the company has no obligation from the forward extra.
    Explanation
    The US company wants to sell its euros for as much as possible i.e. receive as many USD as possible. This means selling Euros at $1.45. Note that if we finish below $1.30 or touch the barrier $1.50, the customer will sell Euro at $1.30.

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  • 10. 

    A new customer of SD, who works on the corporate sales desk of a bank, wants to use SDX-FX to price zero cost structures with his sales margin built-in. He asks you to explain to him how to do this with a risk reversal to ensure he makes a sales margin of $5,000. You explain to him that the best way to do this is to:

    • A.

      Use the solver to solve for the financing leg strike of the risk reversal for the ask price of -$5000

    • B.

      Use the solver to solve for the financing leg strike of the risk reversal for the bid price of -$5000

    • C.

      Generate the pricing table and find the parameters that make the price $5,000

    • D.

      It is impossible to tell him how to do this as he is pricing a zero cost structure

    Correct Answer
    A. Use the solver to solve for the financing leg strike of the risk reversal for the ask price of -$5000
    Explanation
    The correct answer suggests that the best way to achieve a sales margin of $5,000 is to use the solver to solve for the financing leg strike of the risk reversal for the ask price of -$5000. This means that by adjusting the financing leg strike, the customer can ensure that the ask price for the risk reversal is -$5000, which will result in the desired sales margin.

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  • 11. 

    A trader who does a lot of EUR/USD options wants to use his own vols for this currency pair. You tell him:

    • A.

      It is possible to upload his own data. The system will then adjust volatility data for other currency pairs based on what he uploaded for EUR/USD.

    • B.

      It is possible to upload his own data for EUR/USD. The system will use SD data for other currency pairs.

    • C.

      This is not possible as SD's main advantage is that we show non-biased independent market data.

    Correct Answer
    B. It is possible to upload his own data for EUR/USD. The system will use SD data for other currency pairs.
    Explanation
    The correct answer states that it is possible for the trader to upload his own data for EUR/USD and that the system will use SD (standard deviation) data for other currency pairs. This implies that the trader can customize the volatility data for EUR/USD according to his own preferences, while still relying on the system's standard deviation data for other currency pairs. This allows the trader to have control over the volatility data for EUR/USD while still benefiting from the unbiased and independent market data provided by the system for other currency pairs.

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  • 12. 

    Which of these USD/JPY options is the most expensive: Forward Rate = 80 Notional = 1m Strike = 85

    • A.

      USD put JPY call, expiry one year

    • B.

      USD call JPY put, expiry one year

    • C.

      USD call JPY put, expiry one month

    • D.

      USD put JPY call, expiry three months

    Correct Answer
    A. USD put JPY call, expiry one year
    Explanation
    The Long Dated ITM option will be the most expensive. This will be the USD Put in this case since the 85 strike Put will be ITM and the 85 strike call is OTM, with the longest expiry.

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  • 13. 

    An option will always be cheaper if priced using historical volatility rather than implied volatility - Is this statement by a client true or false?

    • A.

      True

    • B.

      False

    Correct Answer
    B. False
    Explanation
    Sometimes historical volatility is higher than the implied volatility for the same period and sometimes it is lower, there is no rule.

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  • 14. 

    If a US Company with 10m Euros worth of receivables (sales) to collect in one year's time enters into an option contract where they buy a EUR Put with a strike of $1.25 at a cost of $0.06 per Euro. Which of the following is true if on expiry the EUR/USD finishes at $1.23:

    • A.

      They will exercise their option and receive $12.5m.

    • B.

      They will not exercise their option since it will not breakeven.

    • C.

      They will exercise their option and receive $11.9m.

    Correct Answer
    A. They will exercise their option and receive $12.5m.
    Explanation
    The option will be exercised on expiry as it is ITM, regardless of whether it covers the original premium i.e., in this case, the 'break-even' strike would have been $1.19 but that is irrelevant when considering whether to exercise.

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  • 15. 

    A corporate price up a risk reversal in SD that was offered to them at zero cost with a notional of $1M. They see that the market value of the structure is -$10,000. What does this value mean?   

    • A.

      The corporate should receive 10K but in fact the bank is keeping this as a sales margin

    • B.

      The structure actually costs $10k but because of the CVA adjustment they don’t need to pay anything

    • C.

      $10k is a negligible amount on this size of notional therefore requiring no payment by the corporate

    Correct Answer
    A. The corporate should receive 10K but in fact the bank is keeping this as a sales margin
    Explanation
    The market value of the structure being -$10,000 means that the corporate should receive $10,000 from the bank. However, the bank is keeping this amount as a sales margin instead of paying it to the corporate.

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  • 16. 

    Japanese Exporters prefer a weak Yen over a strong Yen.

    • A.

      True

    • B.

      False

    Correct Answer
    A. True
    Explanation
    Assuming when they export, Japanese firms charge customers in Yen, then if the Yen is weak, it will cost foreign buyers less money in their own currencies ..  This will encourage them to buy Japanese/Yen  denominated goods and services.

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  • 17. 

    A call option is an American style when it can be exercised ...

    • A.

      Only on the expiry date

    • B.

      Any time from the trade date to expiry

    • C.

      When the expiry is set to 10:00 AM New York time

    • D.

      Only by an American bank with clearinghouse acceptance

    Correct Answer
    B. Any time from the trade date to expiry
    Explanation
    Fact.

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  • 18. 

    A company based in Europe comes to you for advice on what to do with the $10m USD they will receive in one year from a large sale in US.  Which of the following best describes the company’s position:

    • A.

      They are NOT exposed since the amount of their US sales is known in advance

    • B.

      They are NOT exposed since the Euro forward rate is higher than the spot rate and therefore the Euro is expected to rise

    • C.

      They would like protection against the Euro weakening against the USD

    • D.

      They would like protection against the Euro strengthening against the USD

    Correct Answer
    D. They would like protection against the Euro strengthening against the USD
    Explanation
    In the future, the company will need to turn their USD into Euro. Without hedging, they will therefore benefit if the USD strengthens as this will mean each USD turns into more Euro and suffer if the USD weakens as this would mean each USD would turn into less Euro. Since they will benefit from the EUR/USD weakening i.e. going down, you could also their exposure makes them 'short EUR/USD', or short Euro's against the USD.

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  • 19. 

    When you price up an option on GBP/THB in the single options page and the ATM vol turns pink. Why is this?

    • A.

      It means the volatility is cross-calculated

    • B.

      It means the volatility is stale

    • C.

      It means the volatility is about to change

    • D.

      It means the volatility is from one source

    Correct Answer
    A. It means the volatility is cross-calculated
    Explanation
    Cross calculating means taking the USD/THB Vol and the GBP/USD Vol and the historical correlation between these two exchange rates to calculate the anticipated volatility of GBP/THB e.g. if the USD historically strengthens and weakens against both the GBP and the THB at the same time, then the GBP/THB exchange rate would remain relatively stable.

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  • 20. 

    Which of the following represents a situation where the price of the call option you buy equals the price of the put option you sell?

    • A.

      A. The strike of the options is the prevailing forward rate

    • B.

      B. Zero cost risk reversal

    • C.

      C. Risk reversal with total premium of -10,000

    • D.

      D. Both A & B

    Correct Answer
    D. D. Both A & B
    Explanation
    The correct answer is D. Both A & B. This means that both situations A and B represent a scenario where the price of the call option you buy is equal to the price of the put option you sell. In situation A, the strike of the options is the prevailing forward rate, while in situation B, it is a zero cost risk reversal.

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  • 21. 

    The pricing of a quanto option takes into account:

    • A.

      The market data of the Quanto's underlying currency pair

    • B.

      The market data of the currency pair created as a result of the payout currency

    • C.

      The correlation between the underlying currency pair and the currency pair created as a result of the payout currency

    • D.

      All of the above

    Correct Answer
    D. All of the above
    Explanation
    The pricing of a quanto option takes into account the market data of the Quanto's underlying currency pair, the market data of the currency pair created as a result of the payout currency, and the correlation between the underlying currency pair and the currency pair created as a result of the payout currency. All of these factors are considered in order to accurately price the quanto option.

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  • 22. 

    A vanilla option cannot be priced without a notional.

    • A.

      True

    • B.

      False

    Correct Answer
    B. False
    Explanation
    This statement is false. A vanilla option can be priced without a notional. The notional value is the predetermined amount of the underlying asset that the option controls. While the notional value is often used in pricing and determining the size of the position, it is not a requirement for pricing the option itself. The price of a vanilla option is determined by various factors such as the current price of the underlying asset, the strike price, the time to expiration, and market volatility.

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  • 23. 

    As an employee of SD, your family always think you are a master of derivatives and ask lots of questions. While going through one of your lengthy explanations of volatility and vega, you try and explain to them about the relationship between Time Value and the value of an option. Which of the following options will have the highest Time Value?

    • A.

      Short dated, ATM option.

    • B.

      Long dated, ATM option.

    • C.

      Long dated, deeply OTM option.

    • D.

      Long dated, deeply ITM option.

    Correct Answer
    B. Long dated, ATM option.
    Explanation
    Time value is a measure of the uncertainty of exercise. It increases as the time to expiry is longer and is higher for ATM options, since they have more 'uncertainty of exercise'. Note deeply OTM and ITM options both have low Time Value since they are highly likely to expiry worthless/be exercised.

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  • 24. 

    While standing in the elevator with the head of trading on the way to a meeting room, he mumbles that the EUR/USD has moved 'a big figure' in the first hour of trading. If the opening EUR/USD rate was 1.3250, which of the following would represent a move of one big figure?

    • A.

      1.4250

    • B.

      1.3350

    • C.

      1.3260

    • D.

      1.3251

    Correct Answer
    B. 1.3350
    Explanation
    In most currencies, which stand at a single figure, the 'big figure' will be the second decimal place i.e. 1.3X33 or 1.6X66.

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  • 25. 

    A trader believes there will be a large movement in Spot (larger then 25d) but is uncertain as to the direction. Identify a strategy the trader can follow...

    • A.

      Buy a call and sell a put both at 25d, thus creating a 25d risk reversal

    • B.

      Buy a strangle

    • C.

      Sell a strangle

    • D.

      Sell a double-one-touch (DOT) with triggers at 25d call and 25d put

    Correct Answer
    B. Buy a strangle
    Explanation
    A strangle strategy involves buying both a call option and a put option with the same expiration date, but with different strike prices. This strategy allows the trader to profit from a large movement in the spot price, regardless of the direction. By buying a call option, the trader benefits from an increase in the spot price, while buying a put option protects against a decrease in the spot price. This strategy is suitable when the trader expects a significant movement but is unsure of the direction.

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  • 26. 

    A German computer importer is tendering for a contract to supply the government with PCs manufactured in the US. The importer will know if he won the tender in 6 months and if so will have to buy 10 million USDs worth from the PC supplier 6 months later. The importer believes there is a 50 percent chance he will win the tender. He wants to hedge his exposure now. The current EUR /USD rate is 1.30.  What do you recommend?

    • A.

      Buy EUR/USD call expiry 12 months notional on $5M

    • B.

      Buy EUR/USD put expiry 12 months notional on $5M

    • C.

      Buy a t compound option expiry 6 months for a 6 month EUR/USD put

    • D.

      Buy a 12 month fader with monthly notional accumulating only if the EUR/USD rate is below 1.30

    Correct Answer
    C. Buy a t compound option expiry 6 months for a 6 month EUR/USD put
    Explanation
    Buying a t compound option expiry 6 months for a 6 month EUR/USD put would be recommended in this situation. This strategy allows the importer to hedge their exposure by purchasing the option to sell EUR and buy USD at a specified exchange rate in 6 months. If the importer wins the tender, they can exercise the option and protect themselves from any potential depreciation of the EUR against the USD. If they do not win the tender, they can let the option expire and avoid any unnecessary costs.

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  • 27. 

    A client prices up a Target Redemption Forward whereby they sell 1m Euro (or 2m Euro for OTM fixings) at $1.40 every month until a target intrinsic value of $500,000 is reached.  When they price it on the system, they see a negative ask price i.e. an upfront receipt, of $250,000.   If they increase the forward rate from $1.40 to $1.45, what is the likely impact on the size of this upfront receipt:

    • A.

      It will increase i.e. the upfront will be higher (example - change from -250K to -350K), since the client will reach the target quicker and have less value

    • B.

      It will reduce i.e the upfront will be lower (example - change from -250K to -150K), since selling at a higher rate is always preferable for the client

    • C.

      Is it impossible to say as the upfront could go up or down depending on the probability of reaching the target per expiry

    Correct Answer
    B. It will reduce i.e the upfront will be lower (example - change from -250K to -150K), since selling at a higher rate is always preferable for the client
    Explanation
    Increasing the forward rate from $1.40 to $1.45 means that the client will be selling the Euro at a higher rate. This implies that they will receive more dollars for each Euro sold. Since selling at a higher rate is always preferable for the client, the upfront receipt, which was initially negative at $250,000, will reduce and become lower, for example, at $150,000.

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  • 28. 

    A client says he typically enters into the following structure and asks if we support it? We measure the weekly fixing for EUR/USD throughout the year and at the end of the year, I agree to buy 1m EUR at $1.30 for every week the rate fixed above $1.25, otherwise I have no commitment. Which of the following is most likely what he is looking for?

    • A.

      TARF

    • B.

      Accumulator

    • C.

      Fader

    • D.

      Strip of Forward Extra's.

    Correct Answer
    B. Accumulator
    Explanation
    A TARF has fixings and weekly deliveries (not a single delivery), as well as potentially being knocked out if we accumulate a target profit amount. The Fader accumulates the notional of an option but with no commitment to buy. The strip of forward extra's has US barriers attached. The accumulator commits the client to buy or sell a defined amount for every fixing above/below a defined barrier level.

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  • 29. 

    An investor has $1 million USD to invest. He is offered a DCD with conversion into EUR. The spot rate at that time is 1.3. With all other inputs remaining the same, which of the following will provide the highest annualized yield?

    • A.

      1 year investment with converstion rate at 1.35

    • B.

      1 year investment with converstion rate at 1.25

    • C.

      6 months investment with converstion rate at 1.35

    • D.

      6 months investment with converstion rate at 1.25

    Correct Answer
    A. 1 year investment with converstion rate at 1.35
    Explanation
    The investor should choose the 1 year investment with a conversion rate at 1.35 in order to achieve the highest annualized yield. This is because a higher conversion rate means that the investor will receive more EUR for their initial investment in USD. Therefore, when converting back to USD after 1 year, the investor will receive a higher amount of USD if the conversion rate is 1.35 compared to 1.25.

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  • 30. 

    A trader is reviewing the delta’s shown on SDX and has a query.  He is pricing an OTM option where the market vol is significantly higher than the ATM vol and can only see the TV delta.  What can you tell him about the analytic market delta?

    • A.

      The analytic delta will be higher than the TV delta due to the higher vol

    • B.

      The analytic delta will be higher than the TV delta due to the lower vol

    • C.

      The impact of the higher vol on the delta can’t be predicted

    • D.

      The analytic market delta is always higher than the TV delta, regardless of vol

    Correct Answer
    A. The analytic delta will be higher than the TV delta due to the higher vol
    Explanation
    The reason why the analytic delta will be higher than the TV delta is because the market vol is significantly higher than the ATM vol. Higher volatility leads to larger price movements, which in turn affects the delta of the option. Therefore, the analytic delta, which takes into account the higher vol, will be higher than the TV delta, which does not consider the vol.

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