14-49 If foreign currency exchange rates are highly positively correlated,how can a FI reduce its exchange rate risk exposure?
A)By taking net long positions in all currencies.
B)By taking net short positions in all currencies.
C)By taking opposing net short and net long positions in different currencies.
D)By maximizing net FX exposure in each currency,independently.
E)By minimizing net FX exposure in each currency,independently.

Question

Quizplus · Accepted Answer

By taking opposing net short and net long positions in different currencies, the FI can offset its exposure to exchange rate fluctuations since highly positively correlated currency pairs tend to move in the same direction. This strategy is known as currency diversification and can effectively reduce overall exchange rate risk exposure. Option A and B are not viable as they involve taking extreme positions in all currencies, which would increase risk exposure rather than reduce it. Option D and E are also not recommended as they do not account for the correlation between currencies and may result in unintended exposures.

14-49 If Foreign Currency Exchange Rates Are Highly Positively Correlated,how