Match List - I with List - II regarding foreign exchange concepts:

List - I
(A) Arbitrage
(B) Hedging
(C) Speculation
(D) Foreign exchange risk

List - II
(I) Refers to when an investor accepts and seeks foreign exchange risk
(II) Refers to a time when foreign exchange shifts, causing the spot rate to vary frequently
(III) Refers to purchase of currency in monetary center where it is cheaper
(IV) Refers to avoidance of foreign exchange risk

Correct option is A

Correct ans. (a)
Explanation: 

The correct matching is:

• (A) Arbitrage → (III): Arbitrage involves buying a currency in one market where it is cheaper and simultaneously selling it in another market where it is more expensive. This allows traders to make a profit without any exchange rate risk. It is a fundamental concept in foreign exchange markets, ensuring price consistency across markets.

• (B) Hedging → (IV): Hedging is the strategy used by firms or investors to protect themselves against adverse currency movements. This is typically achieved through instruments such as forward contracts, options, or futures. The primary goal is to avoid foreign exchange risk.

• (C) Speculation → (I): In contrast to hedging, speculation involves taking on foreign exchange risk with the expectation of profiting from favorable movements in exchange rates. A speculator actively seeks exposure to currency fluctuations.

• (D) Foreign exchange risk → (II): Foreign exchange risk arises when there are frequent and unpredictable shifts in exchange rates, leading to potential losses on international transactions or investments.

Hence, option (a) most accurately captures the relationships between each concept and its description.

Information Booster

• Arbitrage ensures market efficiency by exploiting price differences.

• Hedging protects businesses from exchange rate volatility, maintaining budget certainty.

• Speculators take calculated risks, aiming to earn from currency movements.

• Forex risk impacts companies involved in import-export, FDI, or overseas borrowing.

• Tools for hedging include forwards, futures, and currency swaps.

• Central banks may intervene in forex markets to reduce excessive speculation.

• Arbitrage opportunities diminish rapidly due to high-speed electronic trading platforms.