Statement I is correct. The Exchange Fund Bills and Notes Programme, initiated in 1990, was a key government initiative to develop the local debt market. It successfully established a reliable benchmark yield curve for Hong Kong dollar debt, which is crucial for the pricing of private sector debt securities. Statement II is incorrect. Hong Kong’s debt market is highly internationalised and open. There are no specific restrictions that prevent foreign entities from issuing debt in Hong Kong or foreign investors from participating in the market. Statement III is incorrect. While the Central Moneymarkets Unit (CMU) is the primary clearing system for Hong Kong dollar denominated debt, it is not exclusive for all securities. Most foreign-denominated debt securities are cleared through international systems like Euroclear and Clearstream (formerly Cedel). Statement IV is correct. The Hong Kong Mortgage Corporation (HKMC) is a key player in the local structured finance market. Its primary function involves purchasing mortgage loans from banks and then securitising them by issuing mortgage-backed securities (MBS), which are then sold to investors. Therefore, statements I and IV are correct.

Under the Securities and Futures (Financial Resources) Rules (FRR), a licensed corporation must maintain liquid capital that is not less than its required liquid capital. The calculation involves deducting ranking liabilities from liquid assets. Ranking liabilities are defined as all liabilities of the corporation, with certain specific exceptions.

Statement I is incorrect. A subordinated loan that has been approved by the Securities and Futures Commission (SFC) is specifically excluded from the definition of ranking liabilities. Under the FRR, such loans are treated as part of the corporation’s capital base, not as a liability to be deducted for the liquid capital computation, provided they meet all the conditions stipulated by the SFC.

Statement II is correct. Accrued professional fees, such as audit fees, represent a current liability of the firm. As it is an amount owed to a third party, it falls under the definition of a ranking liability and must be deducted when calculating liquid capital.

Statement III is correct. Amounts due to clients for transactions that have already been settled are liabilities of the licensed corporation. These must be included as ranking liabilities in the FRR calculation.

Statement IV is correct. A bank overdraft is a form of borrowing and is a liability of the corporation. The fact that it is secured does not change its nature as a liability that must be deducted from liquid assets. Therefore, statements II, III and IV are correct.

An inverse yield curve, where short-term debt instruments have higher yields than long-term ones, is often interpreted by market participants as a leading indicator of an economic slowdown or recession. The rationale is that investors expect the central bank to lower interest rates in the future to stimulate the slowing economy. In anticipation of falling future interest rates, investors are incentivised to lock in the current, relatively higher long-term yields. This increases demand for long-term bonds, pushing their prices up and their yields down. Consequently, a portfolio manager observing this phenomenon would likely adjust their fixed-income strategy by increasing the portfolio’s duration, which involves shifting allocations towards longer-maturity bonds to benefit from potential price appreciation when interest rates eventually decline.

To answer this question correctly, one must understand the distinct mandates of major global financial institutions. The International Monetary Fund (IMF) was established to promote international monetary cooperation, exchange rate stability, and orderly exchange arrangements. Its primary role is to provide short-term financial assistance to member countries experiencing balance of payments difficulties, often with policy conditions attached (conditionality) to restore macroeconomic stability. In contrast, the World Bank’s main objective is long-term economic development and poverty reduction, which it pursues by providing financing, policy advice, and technical assistance for specific development projects like infrastructure, education, and health. The Bank for International Settlements (BIS) serves as a bank for central banks, fostering international monetary and financial cooperation and acting as a forum for policy discussion among central banks, but it does not lend to national governments for crisis resolution. The Organisation for Economic Co-operation and Development (OECD) is a forum where governments of developed economies work together to seek solutions to common problems, develop global standards, and share policy experiences; it is not a lending institution for financial crises.

The Securities and Futures Commission (SFC) is the primary regulator of Hong Kong’s securities and futures markets. Its functions are defined under the Securities and Futures Ordinance (SFO). Statement I is correct as the SFC is responsible for the licensing regime, granting licenses to corporations and individuals who wish to carry on regulated activities. Statement II is also correct; a key role of the SFC is the ongoing supervision of licensed intermediaries to ensure they comply with the SFO and its subsidiary legislation, including various codes of conduct. Statement IV is correct because the SFC has extensive powers to investigate and take enforcement action against market misconduct, such as insider dealing and market manipulation, to protect investors and maintain market integrity. However, Statement III is incorrect. The function of acting as the lender of last resort to the banking system is a core responsibility of the Hong Kong Monetary Authority (HKMA), not the SFC. The SFC does not provide liquidity support to licensed corporations. Therefore, statements I, II and IV are correct.

Effective corporate governance involves the board of directors actively supervising and controlling the management of a company on behalf of its shareholders. A primary responsibility of the board is to oversee the company’s risk management framework. When a corporation undertakes a significant new venture, such as expanding into a high-risk market, it is crucial for the board to implement direct control mechanisms to manage the associated financial exposures. Establishing clear, board-approved written policies and setting specific investment or capital expenditure limits for the venture are fundamental corporate governance processes. These actions ensure that management operates within a risk appetite defined and approved by the board, thereby protecting shareholder interests. While tools like specific payment systems (e.g., DvP) mitigate settlement risk and obtaining sovereign credit ratings is a prudent part of due diligence, they are components of the overall risk management process rather than the core supervisory function of the board itself. Delegating the entire approval and risk assessment for such a major decision to management without board-level constraints would be an abdication of the board’s oversight responsibilities as stipulated under the Companies Ordinance and principles of good corporate governance.

This question assesses the fundamental characteristics and functions of derivatives. Statement I is correct because a primary and widely recognized function of derivatives is risk management, or hedging. For instance, a company can use a currency forward contract to lock in an exchange rate for a future transaction, thereby hedging against adverse currency movements. Statement II is correct as it provides the core definition of a derivative; its value is not intrinsic but is derived from an underlying asset, which could be a stock, bond, commodity, or interest rate. Statement III is also correct. The derivatives market is a classic example of a ‘zero-sum game.’ For every long position that gains, there is a short position that incurs an equal loss, and vice versa. The net change in wealth is zero. Statement IV is incorrect. Many derivatives markets, particularly exchange-traded ones like index futures, are highly liquid and active, often more so than the market for the underlying assets. This liquidity provides traders with increased flexibility, not less. Therefore, statements I, II and III are correct.

The Hong Kong Monetary Authority (HKMA) provides a mechanism for licensed and restricted licensed banks to manage temporary liquidity shortfalls. This mechanism is known as the Discount Window. Through this facility, banks can obtain intraday liquidity by entering into repurchase agreements (repos) with the HKMA, using eligible securities as collateral. This ensures the smooth functioning of the payment system. The Real Time Gross Settlement (RTGS) system is the infrastructure through which interbank payments are settled individually and in real-time across the books of the HKMA, which helps to eliminate settlement risk, but it is not a liquidity provision facility itself. The Exchange Fund’s primary role is to back the Hong Kong dollar and maintain the stability of the monetary and financial systems, not to act as a routine source of intraday bank liquidity. The Cross-Border Interbank Payment System (CIPS) is related to the clearing and settlement of cross-border RMB payments and is not the HKMA’s facility for domestic intraday HKD liquidity.

Statement I is incorrect. Duration is a measure of interest rate sensitivity that assumes a linear relationship between bond prices and yield changes, and it is most accurate for small, parallel shifts in the yield curve. It does not fully capture the risk from non-parallel shifts or the non-linear relationship (convexity), making it an incomplete assessment of interest rate risk.

Statement II is correct. The measurement of credit risk fundamentally involves two components as per standard industry practice. The first is the likelihood of default (or probability of default), which assesses the chance that an issuer will fail to meet its payment obligations. The second is the loss-given-default (or loss severity), which estimates the portion of the asset’s value that will be lost if a default occurs, often determined by the expected recovery rate.

Statement III is correct. Gap analysis is a primary tool for measuring and managing liquidity risk. It involves systematically mapping out the timing of all expected cash inflows and outflows over various time horizons to identify potential future periods where the entity might face a cash shortfall (a ‘gap’), allowing for proactive funding arrangements.

Statement IV is incorrect. This statement confuses stress testing with a different risk measure. Measuring the value change from a one-basis-point (0.01%) change in yield is the definition of Dollar Value of a Basis Point (DV01), a measure of interest rate sensitivity. Stress testing, in contrast, involves simulating the impact of extreme, large-scale, and often complex market shocks (e.g., a major credit crisis, a sharp and significant interest rate hike) to assess a portfolio’s resilience under ‘worst-case’ scenarios. Therefore, statements II and III are correct.

A competent corporate finance professional must exhibit a blend of technical skills, communication abilities, and strong personal values, especially under pressure. Statement II is correct as maintaining clear, calm communication is crucial for managing the client relationship and demonstrating trustworthiness and competence. Statement III is also correct because effective negotiation involves using all available information to the client’s advantage, which showcases determination and negotiating skill. Statement I reflects poor professional judgment and a lack of self-discipline, as advice should be based on verified information, not panic. Statement IV demonstrates an abdication of senior responsibility; a leader must manage multiple facets of a deal, including client relationships and negotiations, not just the technical analysis. Therefore, statements II and III are correct.

The financial system is broadly divided into the primary market and the secondary market. The primary market is where new securities are created and issued for the first time. An Initial Public Offering (IPO) is a classic example of a primary market transaction, where a company sells its shares to investors to raise capital, and the proceeds go directly to the company. In contrast, the secondary market is where previously issued securities are traded among investors. The company that originally issued the securities is not involved in these transactions. The Hong Kong Stock Exchange (HKEX) is the main venue for secondary market trading of listed securities in Hong Kong. This market provides liquidity, allowing investors to buy and sell securities after their initial issuance. The money market is distinct from both, as it deals with short-term debt instruments, not equities. The over-the-counter (OTC) market involves direct trading between two parties without the supervision of an exchange, which is different from the scenario described involving a listed company on the HKEX.

This question tests the ability to distinguish between strategic, reputation, systemic, and legal risks in a practical scenario. Statement I correctly identifies strategic risk, which is the risk of loss arising from a flawed business plan or the poor implementation of a strategic initiative, such as the new platform failing to achieve its business goals. Statement II is a clear example of reputation risk, where negative public perception and client backlash directly lead to financial and business losses. Statement IV accurately describes legal risk, which involves losses from regulatory sanctions or legal action due to non-compliance with laws and regulations, such as the Securities and Futures Ordinance (SFO) provisions against market misconduct. Statement III incorrectly identifies systemic risk. While a platform failure is a severe operational risk for the firm, systemic risk refers to the risk of a cascading failure throughout the entire financial system (e.g., the collapse of a central clearing house or a major bank). The failure of a single brokerage’s platform is highly unlikely to cause the collapse of the entire market’s settlement system. Therefore, statements I, II and IV are correct.

A contractionary monetary policy involves the central bank increasing short-term interest rates to cool down an overheating economy and control inflation. This action has a direct impact on the credit market. Statement I is correct because commercial banks typically pass on the higher funding costs from the central bank to their customers by increasing their own lending rates, such as the prime rate. Statement II is also correct and describes the core of the ‘credit effect’; as borrowing becomes more expensive, the risk of default increases. To mitigate this risk, banks tighten their lending standards and become more selective in approving loans, which reduces the overall availability of credit. Statement III is incorrect; while higher rates might attract more deposits, the primary credit effect is a tightening or contraction of available credit, not an expansion. Banks become more cautious, not more willing, to lend. Statement IV is incorrect as it describes the opposite of the wealth effect on bonds; when interest rates rise, the market value of existing bonds with lower fixed coupon rates decreases, as new bonds will be issued with more attractive higher rates. Therefore, statements I and II are correct.

The HKSAR Government’s finances are primarily managed through the General Revenue Account (GRA), which handles day-to-day revenue and expenditure. When the government runs a budget surplus, the excess funds are transferred to the fiscal reserves. These fiscal reserves are then placed with the Exchange Fund and form a significant part of its assets, alongside the monetary base. The Exchange Fund’s assets are predominantly invested in foreign currency assets. In a situation where government expenditure exceeds revenue, resulting in a budget deficit, the government must fund this shortfall. The primary mechanism for this is to draw down its accumulated fiscal reserves. Since these reserves are held within the Exchange Fund, such a drawdown directly reduces the total assets of the Exchange Fund. The primary role of the Exchange Fund is to maintain the stability of the Hong Kong dollar under the Linked Exchange Rate System, not to directly finance government operations or alter the monetary base for fiscal purposes.

To answer this question correctly, one must understand the distinct yet complementary roles of the major institutions within the World Bank Group. The World Bank itself, specifically the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA), primarily engages with governments of member countries. Its main function is to provide financing, policy advice, and technical assistance for public sector projects aimed at reducing poverty and promoting development, such as large-scale infrastructure. In contrast, the International Finance Corporation (IFC) is the arm of the World Bank Group that focuses exclusively on the private sector in developing countries. The IFC’s mandate is to advance economic development by encouraging the growth of private enterprise. It achieves this by providing both investment (equity and loans) and advisory services directly to private businesses and projects, often acting as a catalyst to attract other private investors. Therefore, a government seeking a loan for a public works project would approach the World Bank, while a project involving a private sector joint venture would fall under the purview of the IFC.

Statement I is correct. Hong Kong’s financial system is heavily reliant on its banking sector, which is a classic example of indirect financing. Financial intermediaries, such as banks, pool funds from savers (surplus units) and channel them to borrowers (deficit units), forming the primary mechanism for capital allocation in the economy. Statement II is also correct. Maturity transformation is a core function of financial intermediaries. They reconcile the conflicting time preferences of savers, who typically prefer short-term, liquid deposits, and borrowers, who often require long-term loans for investments. Statement III is incorrect. A key role of an intermediary is risk transformation, not risk pass-through. The intermediary assumes the credit risk of the ultimate borrower. The original saver (e.g., a depositor) faces the credit risk of the intermediary (e.g., the bank), not the end-borrower. Statement IV is incorrect. The household sector is typically a net saver or supplier of funds to the financial system. Financial intermediaries are institutions that facilitate the flow of these funds, such as commercial banks, insurance companies, and fund management companies. Therefore, statements I and II are correct.

Statement I is correct. A plain vanilla interest rate swap is the most common type, where one counterparty exchanges fixed-rate interest payments for floating-rate interest payments from another counterparty, based on a notional principal amount.

Statement II is incorrect. A call option gives the buyer the right, but not the obligation, to buy an underlying asset at a specified price (the strike price) by a specified date. The right to sell is characteristic of a put option.

Statement III is correct. The Hong Kong Futures Exchange (HKFE) is the sole operator of the futures and options market in Hong Kong. It is a wholly-owned subsidiary of Hong Kong Exchanges and Clearing Limited (HKEx), which also owns The Stock Exchange of Hong Kong Limited (SEHK).

Statement IV is incorrect. For the seller of a covered call, the maximum profit is limited to the premium received. However, the primary risk is not the loss of the premium but the opportunity cost. If the underlying asset’s price rises significantly above the strike price, the seller is obligated to sell the asset at the lower strike price, thereby forgoing any potential gains beyond that point. The risk is the lost upside potential, not just the premium. Therefore, statements I and III are correct.

The explanation should clarify the distinct primary functions of different financial intermediaries in Hong Kong’s capital markets. Investment banks are key players at the ‘wholesale’ level, acting as intermediaries between corporations seeking to raise capital and investors. Their core, fee-based activities include advising on corporate finance matters such as mergers, acquisitions, and Initial Public Offerings (IPOs), as well as underwriting and distributing new securities issues. This contrasts with a traditional retail brokerage, whose primary function is to execute buy and sell orders for securities on behalf of clients. While a firm can hold multiple licenses and perform various functions, the act of advising on and underwriting an IPO is a hallmark of investment banking. A securities margin financier’s role is specifically to provide credit facilities for clients to trade securities on margin. A deposit-taking company, regulated by the HKMA, is primarily engaged in the business of accepting deposits and providing loans, which is a commercial banking function.

This question assesses the understanding of the fundamental risks associated with Over-the-Counter (OTC) markets. Unlike exchange-traded markets, OTC transactions are bilateral agreements conducted directly between two parties without the intermediation of a formal exchange. The primary risk in such a structure is counterparty risk, which is the risk that one of the parties will not fulfill its side of the contractual obligation (i.e., will default). In an exchange-traded environment, this risk is mitigated by a central counterparty (CCP) or clearing house, which guarantees the performance of trades. In the OTC market, if a counterparty defaults, the non-defaulting party has no such guarantor and must pursue recourse directly, which can be a lengthy and uncertain process, often resulting in significant financial loss. While other risks like market risk (changes in the value of the underlying asset) and liquidity risk (inability to easily unwind the position) exist, the most immediate and critical threat when a counterparty faces insolvency is the complete failure of that counterparty to perform its obligations.

This question assesses the candidate’s understanding of a fund manager’s fiduciary duties and the strategic rationale behind currency hedging. According to the Fund Manager Code of Conduct (FMCC) issued by the SFC, a fund manager’s primary responsibility is to manage the fund in accordance with its stated investment objectives, strategy, and risk profile as disclosed in the offering documents (e.g., the prospectus). The decision to hedge foreign currency exposure is a significant strategic choice that must align with these disclosures. While factors like market forecasts, transaction costs, and the availability of hedging instruments are important tactical considerations in implementing a hedge, the fundamental decision of whether to hedge at all is dictated by the fund’s mandate and the expectations set with investors. A fund whose objective is to deliver returns from underlying assets (like equities) may be required to hedge currency risk to avoid introducing an unintended source of volatility, whereas a global macro fund might intentionally take unhedged currency positions as part of its strategy. Therefore, the most critical factor is ensuring the hedging policy is consistent with the fund’s disclosed objectives and risk parameters.

This question assesses the candidate’s understanding of financial statement analysis and the application of ethical principles under the SFC Code of Conduct. An asset manager’s duty extends beyond accepting reported figures at face value. General Principle 2 of the Code of Conduct requires licensed persons to act with due skill, care, and diligence. In this context, it involves critically evaluating the quality and sustainability of a company’s earnings. Aggressive accounting policies, even if technically compliant with accounting standards, can distort a company’s true economic performance. Recognizing revenue upon shipment to distributors rather than sale to end-customers can inflate current revenues by ‘channel stuffing,’ a practice that is often unsustainable and may lead to future revenue declines or high product returns. A competent analyst must adjust the reported financials to normalize for such policies to understand the underlying cash flow and sustainable earnings power. Relying solely on management’s assurance of compliance, market momentum, or internal pressure would be a failure to exercise professional skepticism and act in the best interests of clients (General Principle 1). The primary analytical task is to determine the real, sustainable profitability of the business before making any investment recommendation.

This question assesses the understanding of standard deviation as a primary measure of investment risk. Standard deviation quantifies the dispersion or volatility of an asset’s returns around its average or expected return. A higher standard deviation implies a wider range of potential outcomes, meaning the actual return is more likely to deviate significantly from the expected return. This indicates greater uncertainty and, therefore, higher risk. In a scenario where two investments have the same expected return, a rational, risk-averse investor would prefer the one with the lower standard deviation because it offers the same potential reward for a lower level of risk. The normal distribution curve for an investment with a higher standard deviation would be flatter and more spread out, visually representing this greater dispersion of possible returns.

This question tests the candidate’s ability to calculate the future value of an investment using the formula for compound interest. The formula is S = P(1 + r/m)^(tm), where S is the future value, P is the principal amount, r is the annual nominal interest rate, m is the number of compounding periods per year, and t is the number of years. In this scenario, the principal (P) is HKD20,000, the annual rate (r) is 6% or 0.06, the time (t) is 2 years, and since interest is compounded quarterly, the number of compounding periods per year (m) is 4. First, calculate the periodic interest rate (r/m), which is 0.06 / 4 = 0.015. Next, calculate the total number of compounding periods ™, which is 2 years 4 quarters/year = 8 periods. Substitute these values into the formula: S = 20,000 (1 + 0.015)^8. This simplifies to S = 20,000 (1.015)^8. Calculating (1.015)^8 gives approximately 1.1264925. Finally, multiplying this by the principal gives S = 20,000 1.1264925 ≈ HKD22,529.85.

Statement I is correct because there is an inverse relationship between interest rates and the market price of fixed-rate bonds. As new bonds are issued at higher interest rates (coupons), existing bonds with lower fixed coupons become less attractive, causing their market price to fall. Statement II is correct because floating-rate notes (FRNs) have coupon payments that are periodically reset based on a benchmark interest rate. In a rising rate environment, these coupon payments will adjust upwards, providing investors with a higher income stream and helping to protect the bond’s capital value. Statement III is incorrect. Zero-coupon bonds are highly sensitive to interest rate changes due to their long duration (as all cash flow is received at maturity). Their price would fall significantly in a rising rate environment, making them an unsuitable choice for capital stability in this scenario. Statement IV is incorrect. The primary risk highlighted by rising interest rates is interest rate risk (the risk of the bond’s price falling), not credit risk. For a high-quality issuer like the HKSAR Government, credit risk (the risk of default) is generally considered very low and is not the main concern in a scenario of monetary policy tightening. Therefore, statements I and II are correct.

The Asian Financial Crisis of 1997 was precipitated by a combination of severe economic vulnerabilities. Statement I is correct because many affected economies, such as Thailand and South Korea, had corporations and banks that borrowed heavily in foreign currencies (primarily US dollars) on a short-term basis to fund long-term domestic investments. This created a dangerous currency and maturity mismatch. When local currencies devalued, the cost of servicing these foreign debts skyrocketed, leading to widespread defaults. Statement II is also correct. Many regional currencies were pegged to the US dollar. This policy encouraged unhedged foreign borrowing and created an illusion of stability. However, as economic fundamentals weakened and the US dollar strengthened, these pegs became overvalued and unsustainable, making them targets for speculative attacks which ultimately forced devaluations. Statement III is incorrect; a key feature of the pre-crisis economies was large and persistent current account deficits, not surpluses. These deficits were financed by the inflow of foreign capital, which made them vulnerable to sudden reversals in capital flows. Statement IV is incorrect as a major contributing factor was weak financial regulation and poor corporate governance, often termed ‘crony capitalism’. This led to inefficient allocation of capital, excessive risk-taking by banks, and a lack of transparency, which exacerbated the crisis once it began. Therefore, statements I and II are correct.

Financial intermediaries perform several crucial functions in capital markets. One of the most important, particularly in secondary markets, is providing liquidity. They often act as ‘market makers,’ who stand ready to buy and sell securities at publicly quoted prices (the bid and offer prices). This function is vital for market health because it ensures that investors can execute trades promptly without causing significant price fluctuations, even for large orders or in less-frequently traded securities. This ‘immediacy’ encourages trading activity. While intermediaries also achieve economies of scale by spreading overhead costs over large volumes, and their fundamental economic role is to channel funds from savers to borrowers, the specific function that addresses the risk of a large trade disrupting the market price is their ability to absorb supply and demand imbalances through market-making.

The fundamental goal of prudential regulation is to ensure the stability, fairness, and integrity of the financial system, thereby fostering public confidence. This is not achieved by micromanaging firms but by establishing a framework that safeguards investors and manages systemic risk. Credit Rating Agencies (CRAs) are vital financial information intermediaries. Their ratings directly influence investment decisions made by both institutional and retail investors. Therefore, a regulator’s primary interest in a CRA’s methodology is to ensure that its assessments are independent, high-quality, and reliable. This allows investors to access the information needed to make informed decisions, which is a cornerstone of a healthy and efficient market. If ratings are perceived as biased or unreliable, investor confidence would diminish, potentially leading to market instability. The regulator’s role is to oversee the system’s integrity, not to guarantee investment outcomes, dictate specific business strategies, or control the internal operations of a licensed entity.

When a private company undertakes an Initial Public Offering (IPO) to list on a stock exchange like the HKEX, it must weigh the benefits against the drawbacks. A primary disadvantage, as stipulated by the principles underlying the Listing Rules, is the dilution of control for the original shareholders. By issuing shares to the public, the ownership base widens, which can reduce the founding owners’ voting power and influence over key corporate decisions. Conversely, listing offers significant advantages. It creates a liquid secondary market, allowing for continuous and transparent valuation of the company’s shares based on market supply and demand, which is a clear benefit over the often complex and infrequent valuation of private company shares. Furthermore, becoming a public entity significantly increases the company’s reporting and compliance obligations under the Listing Rules and the Securities and Futures Ordinance (SFO), leading to higher administrative costs and a greater regulatory burden, not a reduction. Finally, listed status makes it easier and more attractive to implement employee share schemes, as the shares have a readily ascertainable market value and can be easily traded, serving as a powerful tool for talent retention.

Statement I correctly applies the formula for future value under simple interest, which is S = P(1 + r × t). Here, P = HK$100,000, r = 0.04, and t = 5. Statement II is correct because for any period longer than one compounding interval, compound interest will yield a higher future value than simple interest due to the effect of earning ‘interest on interest’. Statement III is incorrect; the ‘interest on interest’ effect is the fundamental principle of compounding and is mathematically relevant even with annual compounding (m=1). More frequent compounding simply accelerates this effect. Statement IV is correct because for a single time period (t=1) with annual compounding (m=1), there has been no prior interest earned to be reinvested. Therefore, statements I, II and IV are correct.

The global foreign exchange (FX) market is fundamentally a decentralized, over-the-counter (OTC) market. This means that transactions are conducted directly between two parties, such as banks, corporations, and investment funds, rather than on a centralized, physical exchange like a stock market. An FX dealer employed by a bank typically performs dual functions: acting as a market maker by providing bid and ask quotes to clients, and engaging in proprietary trading for the bank’s own account. In FX terminology, a currency pair that involves the US dollar (e.g., USD/JPY, EUR/USD) is generally referred to as a ‘major pair’. A ‘cross rate’ or ‘cross currency pair’ is an exchange rate between two currencies, neither of which is the US dollar (e.g., EUR/GBP or AUD/JPY). Furthermore, FX transactions are settled in the respective currencies being exchanged, not necessarily against the US dollar, although the USD is frequently used as a vehicle currency in many transactions.