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FRM Part I · FRM Exam Part I · Foreign Exchange Markets

A country operates a currency board that fixes its currency to a foreign anchor currency. Which statement best describes a defining feature of this regime?

A currency board backs the domestic monetary base with foreign reserves and exchanges at a fixed rate into the anchor currency. Because money supply depends on reserve flows, the central bank loses discretionary monetary policy. Floating and crawling band regimes allow exchange rate flexibility and are therefore different.

  1. AThe central bank freely adjusts the exchange rate to target domestic inflation
  2. BThe domestic monetary base is fully backed by foreign reserves at the fixed rate, limiting discretionary monetary policyCorrect
  3. CThe currency floats and the central bank never intervenes
  4. DThe exchange rate is allowed to move within a crawling band set by the finance ministry

Explanation

A currency board commits to exchange domestic currency for the anchor currency at a fixed rate and holds foreign reserves covering the monetary base. This removes discretion over domestic money creation. The other choices describe managed floats, free floats or crawling bands, which are different regimes.

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