Module: | MODULE A: INTERNATIONAL BANKING
Q3: Consider the following statements regarding the participants and their primary functions within the foreign exchange market. Identify the correct combination.
Statement 1. Arbitrage involves the simultaneous buying and selling of a currency in two different geographical markets to extract a riskless profit from temporary price discrepancies.
Statement 2. A corporate importer in India entering into a forward contract to lock in the purchase price of US Dollars for a payment due in three months is engaging purely in speculative activity.
Statement 3. Market makers in the foreign exchange market provide continuous liquidity by quoting a two-way price, which comprises a bid rate to buy and an ask rate to sell the currency.
Statement 2. A corporate importer in India entering into a forward contract to lock in the purchase price of US Dollars for a payment due in three months is engaging purely in speculative activity.
Statement 3. Market makers in the foreign exchange market provide continuous liquidity by quoting a two-way price, which comprises a bid rate to buy and an ask rate to sell the currency.
✅ Correct Answer: C
🎯 Quick Answer:
Option C accurately isolates the correct statements.Structural Breakdown: Statement I is correct.
Arbitrage is the exploitation of pricing inefficiencies.
If the US Dollar is cheaper in London than in Mumbai, an arbitrageur buys in London and simultaneously sells in Mumbai, making a guaranteed profit with zero net open position.
Statement II is incorrect.
The corporate importer has an underlying physical exposure, which is the future payment.
Using a forward contract to fix the Rupee cost of those US Dollars is called hedging, not speculation.
Hedging neutralizes risk, whereas speculation involves taking on risk to profit from directional price movements.
Statement III is correct.
Major commercial banks act as market makers.
They ensure the market keeps moving by always being ready to buy at their Bid rate or sell at their Ask rate, earning the spread between the two.