Can anyone explain the answer the CFA provides for this question?
Q 17.
Subscriber 2_“I have observed that many of the overseas markets for Korean export goods are slowing, while the United States is experiencing a rise in exports. Both trends can combine to possibly affect the value of the won (KRW) relative to the US dollar. As a result, I am considering a speculative currency trade on the KRW/USD exchange rate. I also expect the volatility in this exchange rate to increase.”_
For Subscriber 2, and assuming all of the choices relate to the KRW/USD exchange rate, the best way to implement the trading strategy would be to:
- write a straddle.
- buy a put option.
- use a long NDF position.
Answer:
C is correct. Based on predicted export trends, Subscriber 2 most likely expects the KRW/USD rate to increase (i.e., the won—the price currency—to depreciate relative to the USD). This would require a long forward position in a forward contract, but as a country with capital controls, a NDF would be used instead. (Note: While forward contracts offered by banks are generally an institutional product, not retail, the retail version of a non-deliverable forward contract is known as a “contract for differences” (CFD) and is available at several retail FX brokers.)
A is incorrect because Subscriber 2 expects the KRW/USD rate to increase. A short straddle position would be used when the direction of exchange rate movement is unknown and volatility is expected to remain low.
B is incorrect because a put option would profit from a decrease of the KRW/USD rate, not an increase (as expected). Higher volatility would also make buying a put option more expensive.
How was I supposed to know that Korea was implementing capital controls? Is it tacitly said and I missed it or is this purely a deduction exercise?