Chapter 10 Currency Management Flashcards
CFAI Currency Management Flashcards
Base
With respect to a foreign exchange quotation of the price of one unit of a currency, the currency referred to in “one unit of a currency.”
Basis risk
The risk resulting from using a hedging instrument that is imperfectly matched to the investment being hedged; in general, the risk that the basis will change in an unpredictable way.
Bid price
In a price quotation, the price at which the party making the quotation is willing to buy a specified quantity of an asset or security.
Carry trade
A trading strategy that involves buying a security and financing it at a rate that is lower than the yield on that security.
Cross hedge
A hedge involving a hedging instrument that is imperfectly correlated with the asset being hedged; an example is hedging a bond investment with futures on a non-identical bond.
Currency overlay programs
A currency overlay program is a program to manage a portfolio’s currency exposures for the case in which those exposures are managed separately from the management of the portfolio itself.
Delta hedging
Hedging that involves matching the price response of the position being hedged over a narrow range of prices.
Domestic asset
An asset that trades in the investor’s domestic currency (or home currency).
Domestic currency
The currency of the investor, i.e., the currency in which he or she typically makes consumption purchases, e.g., the Swiss franc for an investor domiciled in Switzerland.
Domestic-currency return
A rate of return stated in domestic currency terms from the perspective of the investor; reflects both the foreign-currency return on an asset as well as percentage movement in the spot exchange rate between the domestic and foreign currencies.
Dynamic hedge
A hedge requiring adjustment as the price of the hedged asset changes.
Foreign assets
Assets denominated in currencies other than the investor’s home currency.
Foreign currency
Currency that is not the currency in which an investor makes consumption purchases, e.g., the US dollar from the perspective of a Swiss investor.
Foreign-currency return
The return of the foreign asset measured in foreign-currency terms.
Forward rate bias
An empirically observed divergence from interest rate parity conditions that active investors seek to benefit from by borrowing in a lower-yield currency and investing in a higher yield currency.
Funding currencies
The low-yield currencies in which borrowing occurs in a carry trade.
Hedge ratio
The relationship of the quantity of an asset being hedged to the quantity of the derivative used for hedging.
Home currency
Domestic currency The currency of the investor, i.e., the currency in which he or she typically makes consumption purchases, e.g., the Swiss franc for an investor domiciled in Switzerland.
Intrinsic value
The difference between the spot exchange rate and the strike price of a currency option.
Investment currencies
The high-yielding currencies in a carry trade.
Knock-in/knock-out
Features of a vanilla option that is created (or ceases to exist) when the spot exchange rate touches a pre-specified level.
Minimum-variance hedge ratio
A mathematical approach to determining the optimal cross hedging ratio.
Non-deliverable forwards
Forward contracts that are cash settled (in the non-controlled currency of the currency pair) rather than physically settled (the controlled currency is neither delivered nor received).
Offer price
The price at which a counterparty is willing to sell one unit of the base currency.
Overbought
When a market has trended too far in one direction and is vulnerable to a trend reversal, or correction.
Oversold
The opposite of overbought; see overbought.
Put spread
A strategy used to reduce the upfront cost of buying a protective put, it involves buying a put option and writing another put option.
Resistance levels
Price points on dealers’ order boards where one would expect to see a clustering of offers.
Seagull spread
An extension of the risk reversal foreign exchange option strategy that limits downside risk.
Static hedge
A hedge that is not sensitive to changes in the price of the asset hedged.
Stops
Stop-loss orders involve leaving bids or offers away from the current market price to be filled if the market reaches those levels.
Support levels
Price points on dealers’ order boards where one would expect to see a clustering of bids.
Time value
The difference between the market price of an option and its intrinsic value, determined by the uncertainty of the underlying over the remaining life of the option.
