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Answer: The value of a country's currency will be negatively correlated with a factor representing changes in that country's money supply.
D is correct. As described on p. 116, "if Country A increases its money supply by 25% while Country B keeps its money supply unchanged, the value of Country A's currency will tend to decline by 25% relative to Country B's currency." This implies that there is a negative correlation between a country's currency value and changes in its money supply. Option A is incorrect because future exchange rates cannot be predicted with any precision. Option B is incorrect as political instability would weaken a currency, but supply and demand are the most important factors. Option C is incorrect because exchange rates should be assumed to change even in short-term time horizons.
Author: LeetQuiz Editorial Team
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In the context of developing a new factor model designed to evaluate potential risk exposures in foreign exchange (FX) trades, which statement below would be considered the most precise and relevant for a quantitative analyst at a foreign exchange trading firm to consider when assessing potential factors and their influence on the model's effectiveness?
A
Using a large number of underlying factors will allow the model to correctly predict future exchange rates.
B
The most important factor in predicting a country's interest rates is the political stability of the country.
C
The pair-wise exchange rates for currencies of developed countries can be assumed to be constant for terms shorter than 3 months.
D
The value of a country's currency will be negatively correlated with a factor representing changes in that country's money supply.
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