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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 the US dollar. Which statement best describes a defining feature of this regime compared with a conventional fixed peg managed by a central bank?

A currency board fully backs the domestic monetary base with foreign reserves at the fixed rate, so the central bank cannot create money at discretion. This differs from a conventional peg, where policymakers retain some discretion, and from dollarization, where the domestic currency is abandoned.

  1. AThe domestic monetary base is fully backed by foreign reserves at the fixed rate, limiting discretionary monetary policyCorrect
  2. BThe exchange rate is allowed to float within a wide band set by the central bank
  3. CThe central bank can freely print currency to finance government deficits while holding the peg
  4. DThe currency is replaced entirely by the US dollar as legal tender

Explanation

A currency board commits to issuing domestic currency only against foreign reserves at a fixed rate, removing discretionary monetary policy. Floating within a band describes a different regime. Free money printing would break the backing rule. Replacing the currency with the dollar is dollarization, not a currency board.

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