ACT Practice

paper
Certificate in Treasury (CertT)
Unit 1 Context of Treasury

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 Cert T: Unit 1 The Context of Treasury

Practice paper for Unit 1 of the Certificate in Treasury (CertT)

Based on the syllabus assessed from 01 June 2016 to 31 December 2021

Introduction
This practice paper has been produced by the Awarding Body at the Association of Corporate Treasurers
(ACT) to assist students in their preparation for the CertT assessments. It contains a practice exam for
the specified unit as well as practice answers.

Ideally, students should have completed the majority of their CertT studies for Unit 1 before attempting
this practice paper. Students should allow themselves 120 minutes to complete the exam. They should
then review their performance to identify areas of weakness on which to concentrate the remainder of
their study time.

Although the practice exam in this guide is typical of a CertT assessment, it should be noted that it is not
possible to test every single aspect of the syllabus in any one particular exam. To prepare properly for
the examination, candidates should make full use of the tuition options where available and read as
widely as possible to ensure that the whole syllabus has been covered.

Assessment technique: CertT

This paper is a professional paper that as well as testing theory expects application to practice at an
operational level.

The best way to approach written assessments is to work methodically through the questions.
Candidates should not spend too much time on any one question if you are struggling to think of an
adequate answer. Remember you can flag any question to come back to later should you want to
continue your way through the exam.

When all of the questions have been answered, it is prudent to use any remaining time to go through
each question again, carefully, to double-check that nothing has been missed. Altering just one response
could make the difference between passing and failing.

Please ensure you show your workings within your answer when prompted as this means there are
marks available for the workings out. You will be able to make rough workings on a piece of paper during
the exam and on screen should you wish to, however these will not count towards your final mark.

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 Cert T: Unit 1 The Context of Treasury

Assessment information
The CertT assessments all consist of 37 questions, split into sections A, B and C; each assessment is worth
a total of 100 marks.

CertT assessment test specification:

Section Amount of questions
Section A Section A is made up of
20 Multiple Choice
questions and 10
Multiple Response
questions.
Section B 3 longer form questions
Section C 4 longer form questions
Total 37
Marks available Question format
30 This section will test a cross-section
of knowledge to achieve breadth of
syllabus coverage.
30 This section will test knowledge,
analysis, application and justification
as appropriate.
40 This section will be based on mini-
scenarios common to practice.
Questions will test knowledge,
analysis, application and justification
as appropriate
100

Under exam conditions, 2 hours (120 minutes) is allowed for the CertT assessments.

When you take your actual exam, you will be sitting online using your own PC/Laptop. You have access to
an online scientific calculator, but for the purpose of this test, you may use a non-programmable scientific
calculator. There is a formula sheet located on page 17 that will also be accessible during your online
assessment.

In order for you to determine how well you have performed, exemplar answers are listed at the end of
this paper. There are also references to the relevant Learning Outcomes if you need to revisit the
associated material.

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 Cert T: Unit 1 The Context of Treasury

Section A – 30 marks
This section consists of 20 Multiple Choice questions and 10 Multiple Response
questions

1 Which of the following is the present value of a receipt of SGD100m which is expected in 2
years’ time if the appropriate cost of capital is 3.5%?
A SGD96.6m.
B SGD93.35m.
C SGD99.7m.
D SGD95.2m.

2 Which of the following is the annual effective rate on a GBP10m deposit paying interest
monthly at a rate of 2.5% nominal?
A 2.53%.
B 2.48%.
C 2.5%.
D 2.32%.

3 Which of the following responses to an identified risk event demonstrates the most risk
tolerant approach?
A Accept and retain.
B Accept and reduce.
C Avoid.
D Accept and transfer.

4 Which of the following defines a par bond?

A bond whose yield represents:
A its coupon rates.
B what the investor is willing to pay.
C the inherent risk of the investment.
D prevalent market rates.

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 Cert T: Unit 1 The Context of Treasury

5 A business has to meet an interest expense budget of USD2.5m, so needs to manage its level of
borrowing. Its budgeted interest rate is 4.5% and opening borrowings are USD80m. What is the
minimum closing balance the organisation must achieve to meet its budget?
A USD65m.
B USD125m.
C USD31m.
D USD70m.

6 A proposed investment in expected to produce annual net cashflows of EUR2m for 20 years,
starting in 1 year’s time, the annual effective cost of capital being 2.75%. Using an annuity
factor to calculate the present value of these cashflows, which of the following is the value of
the proposed investment?
A USD30.45m.
B USD20.14m.
C USD32.33m.
D USD22.21m.

7 How does the concept of arbitrage help to ensure that the interest rate parity theory holds
true?
A Corporate treasury trading disrupts markets but arbitrage realigns them.
B Banks will only trade at rates that hold with the theory as arbitrage ensures good value.
C Misalignments in markets will be exploited by FX traders to eliminate risk free gains.
D Arbitrage ensures that foreign exchange losses can never be balanced by interest rate
differential gains.

8 On which of the following days will a USD:GBP spot trade settle if today is Thursday and Friday
and the following Monday are public holidays?
A Monday.
B Wednesday.
C Thursday.
D Tuesday.

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 Cert T: Unit 1 The Context of Treasury

9 Which of the following is the most likely use of a forward yield curve?
The curve represents:
A the rate a corporate can issue future bonds.
B the market's expectation of future interest rates.
C the cumulative yield when coupons are absent.
D the forward foreign exchange market.

10 Which of the following is the appropriate discount factor to use to calculate the net present
value of a receipt due in 3 years’ time if the prevailing cost of capital is 4%?
A 0.889.
B 0.925.
C 0.878.
D 0.973.

11 A company has issued a discount instrument with a face value of USD10m, a maturity of 45
days and an annual discount rate of 3.25%. Which of the following are the proceeds of the
issue?
A USD9,874,563.
B USD9,959,539.
C USD9,960,091.
D USD9,953,623.

12 Which of the following pairs of duties would it be appropriate to segregate between a front
and back office?
A Confirming the deal with the counterparty and authorising settlement.
B Initiating and authorising settlement via an appropriate bank account.
C Authorising the position and deal execution.
D Analysis of the exposure and settlement of the proposed transaction.

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 Cert T: Unit 1 The Context of Treasury

13 Which of the following statements relating to a discount instrument is true?

It:
A pays face value at maturity which is less that the value at issue.
B pays a return by being sold at a discount with face value paid at maturity.
C allows the purchaser to borrow money at prevailing market rates.
D is sold at a discount to prevailing market rates on issue.

14 Your finance director is considering an investment in a project. The cost of capital for this
project is 5.5%. Which of the following is the discount factor that would apply in year 3 when
calculating the net present value of the investment?
A 0.898.
B 0.863.
C 0.852.
D 0.948.

15 A discount instrument with a market issue price of GBP11m is issued with a maturity of 91
days, when it will return GBP11.15m. Which of the following is the periodic discount rate of
this discount instrument?
A 1.35%.
B 5.39%.
C 5.46%.
D 1.34%.

16 Given the market information below, at which of the following rates would a corporate
exchange USD for the immediate purchase of goods from Brazil?

A 3.9212.
B 3.8958.
C 3.9239.
D 3.8965.

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 Cert T: Unit 1 The Context of Treasury

17 A back office team within the treasury function is usually responsible for:
A ensuring that all deals are within the internal limits for each counterparty set by the board.
B deciding the most appropriate response to the risks identified.
C analysing positions to understand the magnitude of the risks faced.
D executing proposed transactions with banks at the best price.

18 Which of the following statements relating to participants in the foreign exchange market is
true?
A The market taker buys the variable currency at the offer price.
B The market maker buys the variable currency at the offer price.
C The market maker sells the base currency on the left hand side.
D The market taker buys the base currency at the bid price.

19 Which of the following statements explains why FX rates differ in the spot and forward
markets?
A The rates reflect the supply and demand for the relevant currencies at different time
periods.
B There is less certainty forward so the rates are always more expensive in the forward
market.
C The forward rates take account of interest differentials in the relevant countries for the
appropriate period.
D Forward rates take account of the risk inherent in the foreign exchange markets for the
appropriate period.

20 A discount instrument with a market issue price of GBP11m is issued with a maturity of 91
days, when it will return GBP11.15m. Which of the following is the equivalent annual nominal
rate of this discount instrument?
A 5.47%.
B 4.60%.
C 5.39%.
D 5.44%.

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 Cert T: Unit 1 The Context of Treasury

21 Which of the following are disadvantages of a decentralised treasury structure?

Select ALL that apply.
A Lack of capacity to undertake speculative treasury operations.
B Lack of local autonomy can effect local banking knowledge and relationships.
C Similar treasury tasks will be replicated across group subsidiaries.
D The need to deploy sophisticated treasury systems across the organisation.
E A lack of economies of scale in banking services.

22 Which of the following are advantages of a cost centre approach to treasury?

Select ALL that apply.
A It encourages innovation within the treasury team.
B It aims to minimise the impact of financial volatility on treasury operations.
C It allows treasury risk to be managed with a view to adding value.
D It allows treasury to monitor the market when trading is advantageous.
E It allows commercial decisions to be taken with reasonable certainty.

23 Which of the following are benefits of using a web-based portal for foreign exchange dealing?
Select ALL that apply.
A It allows for more complex foreign exchange contracts to be priced.
B It allows banks to provide a more personal service online.
C There is less opportunity for misunderstanding when contracting with the bank.
D More favourable rates are always available on a web-based portal compared to other
dealing methods.
E It facilitates straight through processing of confirmations.

24 Which TWO of the following tasks would fall under the remit of cash management
responsibilities in treasury?
A Managing large supplier terms and conditions.
B Sourcing funds efficiently from private and public markets.
C Optimising the use of surplus funds.
D Assisting with the organisation's risk management policies.
E Monitoring bank account balances to give transparency over funds held.

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 Cert T: Unit 1 The Context of Treasury

25 Which TWO of the following are characteristics of an in-house bank?

A External transactions are netted to provide relationship banks with a better mix of business.
B Internal foreign exchange positions are netted in order to reduce banking costs.
C Intercompany transactions are netted to eliminate the need for banking arrangements
overseas.
D External transactions are netted in order to reduce the requirement for intercompany loans.
E Treasury decisions are made locally but executed under an agency arrangement.

26 Which TWO of the following are the main roles played by central banks in major developed
economies where there is no official rate of exchange?
A The central bank may seek to smooth out fluctuations in currency movements by trading
foreign exchange with other central banks.
B The central bank will act as the counterparty in all foreign exchange transactions.
C The central bank will maintain control over the supply of money.
D The central bank may speculate on domestic currency markets where they believe gains can
be achieved.
E The central bank will limit the number of imports and exports due to their influence on the
foreign exchange rates.

27 Which of the following are examples of annuities?

Select ALL that apply.
A Annual pension payments.
B Certificates of deposit.
C Zero coupon bonds.
D Corporate issued floating rate notes.
E Fixed rate interest payments on loans.

28 Which of the following statements explains why a yield curve would be positive?
Select ALL that apply.
A The interest rate parity principle means that longer dated foreign exchange rates determine
higher interest rates at the further dates.
B The expectation within markets is that interest rates will rise in the future.
C The forward yield curve will always reflect the difference between the par and zero coupon
curves.
D Market participants will expect greater yield for tying up funds for longer periods.
E The supply of funds will always be higher as required tenor lengthens.

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 Cert T: Unit 1 The Context of Treasury

29 Which of the following are the main risks of hedging foreign exchange positions relating to
forecast receipts?
Select ALL that apply.
A The rate in the foreign exchange market becomes less attractive than the contracted rate.
B The rate in the foreign exchange market becomes more favourable than the contracted rate.
C Lack of availability of an appropriate cross-rate in the market.
D Due to market changes the counterparty bank decides not to honour the contract.
E There are actual variances in amounts received compared to the forecast.

30 Which of the following are ways in which treasury can support its aim of preserving cash and
financial assets?
Select ALL that apply. Treasury can:
A centralise its operations at head office.
B promote a culture of sound financial practice.
C ensure it realises a synergy of expertise in the centre.
D manage the financial risk of the organisation.
E ensure it only borrows funds from domestic banks.

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 Cert T: Unit 1 The Context of Treasury

Section B – 30 marks
This section consists of 3 longer form questions

1.

Discuss:

a) TWO advantages of a decentralised treasury function.

(4 marks)
b) THREE disadvantages of a decentralised treasury function.
(6 marks)

(Total 10 marks)

2.

Discuss:

a) THREE roles you would expect to find in a treasury department’s front office.
(6 marks)

b) TWO reasons why an organisation might segregate its treasury operations into separate front and
back offices.
(4 marks)
(Total 10 marks)

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 Cert T: Unit 1 The Context of Treasury

3.

Today’s short-term GBP forward yield curve is quoted as:

Maturity Quoted forward yield Period

0 – 3 months 2.0% 1
3 – 6 months 2.0% 2
6 – 9 months 2.5% 3

Assuming an initial investment of GBP2m, with re-investment of maturing proceeds in the later periods:

a) Calculate the maturing investment values at the end of periods 1, 2 and 3.

Show your workings
(3 marks)

b) Calculate the periodic yields for the periods 0-6 months and 0-9 months from the cash flows at 6
and 9 months respectively (as calculated in a).
Show your workings
(4 marks)

c) Calculate the nominal annual yields for the periods 0-6 months and 0-9 months from the periodic
yields for the 6-month and 9-month zero coupon periods (as calculated in b).
Show your workings
(3 marks)
(Total 10 marks)

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 Cert T: Unit 1 The Context of Treasury

Section C – 40 marks
This section consists of 4 case study form questions

1.

You currently work as an assistant in the cash and liquidity management team within a large treasury
department. A vacancy has arisen in the corporate financial management team of the department and
you are considering applying for this role.

The corporate financial team leader provided potential applicants with the opportunity to spend a day
with the team to learn more about it and you have just completed this day with three other people who
are also thinking about applying for the vacancy.

The team leader has requested all applicants for the role to include, with their formal applications, a brief
summary of their understanding of the key tasks of the financial management team and its responsibilities
with regard to both corporate finance and investment management.

a. Describe FOUR key tasks of a typical corporate financial management team.

(4 marks)
b. Discuss THREE typical responsibilities of the corporate finance team.
(3 marks)
c. Discuss TWO important responsibilities of the investment management team.
(3 marks)

(Total 10 marks)

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 Cert T: Unit 1 The Context of Treasury

2.

Your treasury manager has substantial surplus USD funds to invest and has identified two different
investments which they wish to research further before making a final investment decision. They have
provided you with the following details of the two investments:

• a deposit account with a nominal annual yield of 3.0%, paying interest quarterly.
• a 60-day discount instrument quoted at a nominal annual discount rate of 2.95%.

The treasury manager has asked you which of these two alternatives will provide the best annual
effective rate of return, as that information will be a key part of their eventual decision.

a. Calculate the annual effective rate of return for the deposit account.
Show your workings
(2 marks)

b. Calculate the annual effective rate of return for the 60-day discount instrument.
Show your workings
(3 marks)

c. Recommend to your manager the best alternative for the investment, based on return alone.
Show your workings
(1 mark)

d. Explain briefly TWO other relevant factors you would mention to your manager which could impact
on the eventual investment decision, regardless of the rate of return.
(4 marks)

(Total 10 marks)

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 Cert T: Unit 1 The Context of Treasury

3.

You are working in the foreign exchange (FX) team within your organisation’s treasury department. You
have been asked to support a new team member who is learning how to undertake spot transactions.
The global nature of your organisation means that transactions are required in a range of currencies.

The new team member has been asked to find an applicable rate for a forthcoming transaction which will
involve the purchase of Hong Kong Dollars (HKD) and the sale of Swiss Francs (CHF).

The new team member is uncertain as to how to proceed because they cannot find a quote for this
currency pair. They have therefore asked for your help, having established the following:

Currency Pair Bid Price Offer Price

USD / HKD 7.7514 7.7515
USD / CHF 0.9177 0.9180

a) Explain to your colleague how an appropriate spot rate for this currency pair would be
established in practice.
(3 marks)

b) Calculate the spot exchange rate for the CHF / HKD deal.
Show your workings
(4 marks)

c) Explain to your colleague the impact on the spread for currency deals like these, compared to
commonly traded currency pairs.
(3 marks)

(Total 10 marks)

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 Cert T: Unit 1 The Context of Treasury

4.

You have a new colleague in your treasury department. They are currently learning the basic aspects of
their new role.
They have heard you mention in the office the terms arbitrage and interest rate parity, but they have told
you that they do not understand what these terms mean.
Also, whilst the new colleague is familiar with spot and forward exchange rates, they are confused
because they have compared today’s spot rate to the rate set 3 months ago for a forward transaction due
to be settled today. They do not understand why the rates do not match.
They have asked you for help to increase their level of understanding.

a. Explain the relationship between arbitrage and interest rate parity.

(4 marks)

b. Explain why forward rates are unlikely to be an accurate indicator of future spot rates.

6 marks)

(Total 10 marks)

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 Cert T: Unit 1 The Context of Treasury

Formulae sheet: Unit 1 The context of treasury

ZERO COUPON PAR RELATIONSHIP

rpar = (1 – DFn) / CumDFn

ANNUITY FACTOR
(1 – (1 + r)–n ) / r

ANNUITY PRESENT VALUE

CF  1 

PV = x 1−
r  (1 + r )n 


PERPETUITY VALUATION

PV = CFt1 / r

GROWING PERPETUITY

PV = CFt1 / (r – g)

INTEREST RATE PARITY FORMULA

𝟏+𝒓𝒂
x Spot (B/A) = Forward(B/A)
𝟏+𝒓𝒃

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 Cert T: Unit 1 The Context of Treasury

Practice guide:
Answers and references to relevant unit and learning outcome

Question Learning Answer Question Syllabus Answer

No. Outcome No. ref:

1 LO5 B 16 LO11 B

2 LO6 A 17 LO3 A

3 LO4 A 18 LO12 B

4 LO8 A 19 LO11 C

5 LO5 C 20 LO7 A

6 LO9 A 21 LO2 C, E

7 LO13 C 22 LO2 B, E

8 LO12 B 23 LO10 C, E

9 LO8 B 24 LO4 C, E

10 LO9 A 25 LO2 B, E

11 LO7 B 26 LO10 A, C

12 LO3 D 27 LO9 A, E

13 LO7 B 28 LO7 B, D

14 LO5 C 29 LO11 B, E

15 LO7 A 30 LO1 B, D

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 Cert T: Unit 1 The Context of Treasury

Question Syllabus ref: Exemplar answers

No.

B1 1.2 Advantages:
• Local autonomy – to take into account local financial market
conditions and the cash and funding requirements of locally
domiciled businesses.
• Alignment of treasury policy with local needs –
organisations operating in a wide variety of product markets
face differing strategic issues in each business, meaning that
head office centralisation in areas such as treasury add
relatively little value.
• Head office costs are reduced – group overheads are
reduced as the centralised function will become smaller;
some of this cost will be transferred to local centres though.

Disadvantages:
• Duplication – each centre will require some treasury
operation, replicating activity across the subsidiaries. This
results in higher local costs.
• Loss of economies of scale – the financial clout of dealing in
larger volume centrally may be lost as each subsidiary
maintains and arranges its own local requirements.
• Need for suitably qualified staff – recruitment, training and
acceptance of corporate ethos is replicated. The
achievement of consistent implementation of policy
becomes more challenging.
• Loss of control – decentralised treasuries require excellent
systems and communication in order to retain control.
• Greater risk – more potential for speculative treasury
operations to manipulate local profitability, leading to
unacceptable risks.
•
B2 1.3 a) A treasury front office executes transactions, and interfaces both
internally with the group’s entities and externally with financial
counterparties. It is responsible for implementing strategy,
working with the business to identify risks, executing and
recording agreed deals. These responsibilities are carried out
by:
• Dealers – responsible for transacting with external banks
and working with the business to identify exposures.
• Risk Manager – managing interest rate and foreign exchange
risk
• Funding Manager – responsible for long term funding
• Treasury Operations Manager – oversees dealer activities.

b) The two key reasons for segregation are to manage fraud and
error. Fraud is managed by ensuring that one member of staff
is not solely responsible for completing major transactions and

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 Cert T: Unit 1 The Context of Treasury

error is managed by building in checking mechanisms – two

heads usually being better than one.

B3 2.4 a) Calculations are as follows:

end of period 1 - 2,000,000 x (1 + (0.02 x 3/12)) = 2,010,000
end of period 2 - 2,010,000 x (1 + (0.02 x 3/12)) = 2,020,050
end of period 3 - 2,020,050 x (1 + (0.025 x 3/12)) = 2,032,675.31

b) Calculations are as follows:

(2,020,050 / 2,000,000) – 1 = 1.0025%
(2,032,675.31 / 2,000,000) – 1 = 1.6338%

c) Calculations are as follows:

1.0025% x 12/6 = 2.005%
1.6338% x 12/9 = 2.178%

C1 1.4 a) The key tasks of a typical corporate finance team are:

• Developing strategies and plans and making investment
decisions that positively affect the value of the corporate.
• Minimising the organisation’s weighted average cost of capital
through capital structuring and the use of tax efficient
instruments and markets.
• Providing a complete, accurate and valid contribution to the
organisation’s external reporting.
• Ensuring that the organisation is fairly evaluated by investors.
• Ensuring that the organisation provides investors with returns
commensurate with the risks that investors take on.

b) The corporate finance responsibilities involve:

• Arranging longer term funding
• Evaluation of potential mergers and acquisitions
• Detailed technical evaluations of potential divestments,
project and investment appraisal and business
developments.

c) The investment management responsibilities involve:

• Longer term (but not short term) investment management
Usually involving setting funds aside appropriately for future
capital investment purposes.

C2 2.3 a) Calculations as follows:

• Convert to periodic yield; [0.03 x (3/12)] x (365/360) =
0.007604167
• Convert to EAR; (1 + 0.00760417)4 – 1 = 0.03077 (3.077%)

b) Calculations as follows:
• Convert to periodic discount; 0.0295 x (60 /360) = 0.0049167
per 60 days
• Convert periodic discount to periodic yield as follows;
0.0049166 / (1 – 0.0049167) = .0049410 per 60 days
• Convert to EAR; (1 + 0.0049410)(365/60) – 1 = 0.03044 (3.044%)

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 Cert T: Unit 1 The Context of Treasury

c) As the discount instrument has a lower EAR than the deposit

account (3.044% compared to 3.077%) then the recommendation
should be to invest in the deposit instrument.

d) The relevant factors are:

• Risk – Better returns are usually offered because the
investor is willing to accept a higher degree of risk. The
alternative suggested needs to be reviewed to ensure that
the level of risk is acceptable to the organisation; i.e. is the
bank/organisation offering the investment sufficiently
trustworthy and reputable to ensure the funds invested are
as safe as they would be with a bank/organisation offering
lower rates of return.
• Maturity – consideration needs to be given as to when the
funds might be required. In this scenario, the discount
instrument offers a higher return and a shorter maturity
date than the deposit account, so maturity isn’t a
consideration; however in many circumstances a higher
return is only achievable by accepting a longer maturity. In
those circumstances maturity becomes an issue because
liquidity has to be foregone for longer and this might create
operational issues.

C3 3.2 a) The process required is to enter into a cross currency deal. This
process enables appropriate rates to be calculated for less
common currency pairs. As most currencies traditionally are
quoted against the USD, it is possible to use USD as a basis for
calculations.

Two transactions take place behind the scenes, involving trades

with USD. For example, to handle the CHF / HKD deal, deals
involving (i) the sale of HKD and the purchase of USD and (ii) the
sale of USD and the purchase of CHF would take place. The USD
transactions would take place behind the scenes at the bank and
would not be visible to the customer.

b) Calculations as follows:

• As USD is on the same side of each currency pair, quotes

are cross divided as follows:
USD/HKD
USD/CHF = CHF / HKD

BID OFFER
USD/HKD 7.7514 7.7515
Divided by 0.9180 0.9177 Crossed over –
USD/CHF bigger number first
=CHF/HKD 8.4438 8.4467

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 Cert T: Unit 1 The Context of Treasury

• As the requirement is to sell CHF, the bid price is applicable,

i.e. 8.4438.

c) The impact of a cross-currency deal is to increase the spread

between the bid and offer prices quoted; the reason being that
the market maker is effectively undertaking two transactions to
meet the customer requirements rather than just one, leading
to more costs.

C4 3.4 a) Students should demonstrate a basic understanding of the

following:

• A definition of arbitrage; e.g. the simultaneous purchase

and sale of assets in multiple markets in order to exploit a
temporary discrepancy in prices.
• In money and FX markets, arbitrage could arise if a borrower
could borrow currency at a favourable agreed fixed interest
rate and exchange it at the spot FX rate and invest the
proceeds at an agreed fixed rate to be re-exchanged on
maturity at a contracted favourable forward FX rate.
• The markets are attuned to this possibility of no risk profits
and therefore arbitrage opportunities are short lived and
small, because the markets eliminate these opportunities.
This is achieved because there is close alignment between
spot, FX and interest rates which lead to parity; i.e. no risk
free profit opportunities.

b) Key points that should be explained by students include:

• The actual spot exchange rate on the maturity date will

almost certainly be different from what the forward
exchange rate is today.
• The future spot rate will reflect the economic circumstances
on that future date, which in turn will be affected by
uncertain future events.

• The forward price derives from the spot rate plus interest
rate differentials, and not directly from market
expectations.

• Within stable markets, the forward rate is theoretically an

unbiased predictor of the future spot rate, although it is
arguable that markets are seldom ‘stable’.

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 Cert T: Unit 1 The Context of Treasury

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