NISM Series I · Unit 1 of 10 · about 10% of the paper
Introduction to currency markets: NISM Series I notes and practice questions
Exchange rates, quotes and how the foreign exchange market works.
What to know in Unit 1
- Quotes and cross rates.
- Spot market and participants.
- Exchange rate regimes.
Key terms, examples and exam traps
Exchange rate
An exchange rate is the price of one currency in terms of another.
Example. USD-INR at 83 means one dollar costs 83 rupees.
Exam trap. This statement is false: An exchange rate is the interest rate on currency loans.
Base and quote currency
In a pair quoted as A-B, A is the base currency and B is the quote currency, and the rate shows units of B per unit of A.
Example. In USD-INR, the dollar is the base and the rupee is quoted.
Exam trap. This statement is false: In USD-INR, the rupee is the base currency.
Direct and indirect quote
A direct quote gives the home currency per unit of foreign currency; an indirect quote gives foreign currency per unit of home currency.
Example. For an Indian dealer, 83 rupees per dollar is direct.
Exam trap. This statement is false: A direct quote shows foreign currency per rupee.
Bid and ask
The bid is the price at which a dealer buys the base currency and the ask is the price at which the dealer sells it, with the ask higher than the bid.
Example. A dealer quotes 82.98-83.02.
Exam trap. This statement is false: The bid is higher than the ask.
Spread
The spread is the difference between ask and bid and is the dealer's margin and a measure of liquidity.
Example. A narrow spread shows a liquid pair.
Exam trap. This statement is false: A wide spread signals high liquidity.
Appreciation and depreciation
A currency appreciates when it buys more foreign currency and depreciates when it buys less.
Example. USD-INR rising from 82 to 84 means the rupee has depreciated.
Exam trap. This statement is false: A rising USD-INR means the rupee has strengthened.
Cross rate
A cross rate between two currencies is derived from their rates against a third, usually the dollar.
Example. EUR-INR is computed from EUR-USD and USD-INR.
Exam trap. This statement is false: Cross rates are fixed by the central bank.
Spot market
In the spot market currencies are bought and sold for settlement in two working days.
Example. A bank buys dollars for delivery after two days.
Exam trap. This statement is false: Spot trades are settled after one year.
Interbank market
The interbank market is where banks trade large amounts of currency among themselves and sets reference rates.
Example. Banks quote to each other over electronic platforms.
Exam trap. This statement is false: The interbank market is only for retail customers.
Market participants
Participants include banks, corporates, exporters, importers, investors, speculators and central banks.
Example. An importer buys dollars to pay a foreign supplier.
Exam trap. This statement is false: Only banks take part in currency markets.
Hedgers and speculators
Hedgers use derivatives to reduce existing currency risk; speculators take risk hoping to profit from price moves.
Example. An exporter sells dollars forward to lock in a rate.
Exam trap. This statement is false: Hedgers aim to profit from price moves.
Arbitrageurs
Arbitrageurs exploit price differences in the same or related instruments across markets to earn low-risk profit.
Example. A trader buys dollars on one venue and sells on another at a higher price.
Exam trap. This statement is false: Arbitrageurs take large directional bets.
Exchange rate regimes
Regimes range from fixed to floating; India follows a managed float where the central bank may intervene to curb volatility.
Example. The RBI sells dollars to steady the rupee.
Exam trap. This statement is false: India has a rigidly fixed rate.
Drivers of exchange rates
Rates move with interest rate differentials, inflation, trade and capital flows, growth and sentiment.
Example. Heavy foreign portfolio inflows strengthen the rupee.
Exam trap. This statement is false: Exchange rates depend only on exports.
Purchasing power parity
PPP says exchange rates adjust so that price levels are equal across countries, so higher inflation tends to weaken a currency.
Example. A country with high inflation sees its currency weaken over time.
Exam trap. This statement is false: PPP says high inflation strengthens the currency.
Foreign exchange reserves
Reserves are foreign currency assets held by the central bank to manage the exchange rate and meet external obligations.
Example. The RBI uses reserves to curb sharp falls.
Exam trap. This statement is false: Reserves are held by commercial banks only.
Balance of payments
The balance of payments records a country's transactions with the rest of the world and is an important driver of currency demand.
Example. A large current account deficit puts pressure on the currency.
Exam trap. This statement is false: The balance of payments records only government spending.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which statement best describes “Spot market”?
- Residents may hold positions in some pairs freely, while in others positions beyond limits require proof of underlying exposure.
- Profit or loss equals the price change multiplied by the lot size and number of lots.
- Hedgers use derivatives to reduce existing currency risk; speculators take risk hoping to profit from price moves.
- In the spot market currencies are bought and sold for settlement in two working days.
Q2. Which term is described here? The bid is the price at which a dealer buys the base currency and the ask is the price at which the dealer sells it, with the ask higher than the bid.
- Interest rate parity
- Bid and ask
- Hedging a receivable
- Investor Protection Fund
Q3. Which term is described here? Reserves are foreign currency assets held by the central bank to manage the exchange rate and meet external obligations.
- Foreign exchange reserves
- Arbitrageurs
- Investor Protection Fund
- Operating range
Q4. Which term is described here? Rates move with interest rate differentials, inflation, trade and capital flows, growth and sentiment.
- Market participants
- Drivers of exchange rates
- Strike price
- Arbitrageurs
Q5. Which term is described here? Regimes range from fixed to floating; India follows a managed float where the central bank may intervene to curb volatility.
- Theta
- Cost of carry
- Position limits and risk
- Exchange rate regimes
Q6. Which term is described here? The balance of payments records a country's transactions with the rest of the world and is an important driver of currency demand.
- Trading hours
- Choosing between futures and options
- Balance of payments
- Accounting at settlement
Frequently asked questions
How much of NISM Series I comes from Unit 1?
Unit 1 (Introduction to currency markets) usually carries about 10% of the questions. The whole exam has 100 questions and the pass mark is 60%.
What should I study in NISM Series I Unit 1?
Quotes and cross rates. Spot market and participants. Exchange rate regimes.
Are these NISM Series I practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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