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

Under a currency board arrangement, which of the following is the defining feature?

A currency board fixes the exchange rate by law and backs the domestic monetary base fully with foreign reserves of the anchor currency. This removes discretionary monetary policy, unlike basket pegs, wide bands or floating regimes with inflation targeting.

  1. AThe central bank sets the exchange rate daily using a basket of trading partner currencies
  2. BThe domestic monetary base is fully backed by foreign reserves at a fixed legal exchange rateCorrect
  3. CThe exchange rate is allowed to float within a wide band without intervention
  4. DThe central bank targets domestic inflation and lets the currency adjust freely

Explanation

A currency board commits to exchanging domestic currency for an anchor currency at a fixed rate, with the monetary base backed by foreign reserves. This removes discretionary monetary policy. The other options describe basket pegs, bands or floating regimes with inflation targeting.

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