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CFA Level I · CFA Level I Exam · Exchange Rate Calculations

Which change in market conditions would most likely cause a dealer to widen the bid-ask spread on a currency pair?

Higher expected exchange rate volatility would most likely widen the spread. When rates move more unpredictably, a dealer bears greater inventory risk and demands more compensation. Greater volume and more competing dealers usually tighten spreads rather than widen them.

  1. AA rise in interbank trading volume
  2. BHigher expected exchange rate volatilityCorrect
  3. CGreater number of competing dealers

Explanation

Higher volatility raises the dealer's risk of holding inventory, so wider spreads compensate for it. Higher volume and more competition both tend to narrow spreads.

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