Currency Management Flashcards
If i am buying a future or a forward, what does that mean for either receive or delivering a currency
It means you are going to BUY/receive the currency at that price
Lets just say i own a place in Medellin, and i am going to sell it in 6 months for 1trillion pesos, how do i hedge out my risk in converting it back into AUD using futures
you SELL a future contract on the COP.
You are going to deliver 1trillion pesos in 6 months
Explain the process of an offsetting transaction. Use a Buy USD example against the EURO
SO, you want to buy 1000 USD in 1 year. Awesome. You buy a future for .8 USD for every Euro. So you’ll get 800 Euros in a year.
You change your mind 6 months in, you wanna offset this transaction, so you enter into the opposite side of the contract, ending in another 6 months. The rate is .9 now, so the Euro has depreciated. So now you have to work out what you need to put up to get your $1000 back in 6 months time.
You’re going to have to put up 900 Euros, so you’ve actually copped a loss. On settlement day, you get 800 and Pay 900 euros.
Rekt.
Formula for return in domestic terms of a foreign asset?
Return in domestic = Return on asset in foreign market * appreciation of foreign currency
I am invested in COP - bought 65,000 shares of Banco Colombia - do i want the COP to go up or down
UP! then when i convert it back into AUD, it is worth more
Variance formula for a one asset portfolio
Variance = variance of foriegn currency + Variance of foreign asset =+ 2*SD foreign asset *SD foreign currency * correlation
If the value of a currency is POSITIVELY correlated with that of a foriegn asset, will that increase of decrease the volatility of that position?
Increase
What is passive hedging and one disadvantage
Fully hedging the value of your portfolio to match that of the benchmark - this is costly as the index changes and you must match thier hedging principles constantly
What is Discrestionary hedging
This is where you can MODERATLEY change the hedging of your portfolio to increase the incremental gains from currency moves
What is active hedging? 1 adv and dis adv
You can yolo, hedge the portfolio as much as you like. you can hedge the cop poisiton, but not the usd position if you want
You have the opportunity to capture significant alpha on currency moves, but can get rekt if you get it wrong
What is currency overlay in risk management
It is giving you currency hedging responsibilities over to a third party and they treat currency as a whole new asset class and can invest in new markets, even where you have no current position
What is an issue with using forwards in currency hedging
It can increase your cash flow volatility because forwards are shorter term that your investment horizons
What are the 4 approaches to TACTICAL currency management
Economic fundamentals
Technical Analysis
Cash and Carry
Volatility trading
What is the economic fundamentals way of tactical currency maagement
It is when there is a long run average of the price of a currency vs another, meaning that there is a long term average. THis means that we can determine when a currency is over or undervalued
Also, it takes inflation numbers into consideration, and how they will effect future rates
What is technical analayis used for in currency management.
Creating alpha.
Assumes histroric is the future and is predictable
Carry trade, how to use it in tactical currency management
If you think a future pricce does NOT truly reflect the future value of the spot rate of a currency, you can long or short it based on that. It is the borrow local, invest foreign based on where you think the currency will go (up or down)
Volatility trading - explain in currency management
It is when you use straddles or strangles to take advantage of volatility in the market
Differences in strangle or straddle
Straddle = ATM calls and puts Strangle = OTM calls and puts - this makes strangles cheaper, but lower upside too
Why are forwards preferred in currency management
OTC (customizable)
Some pairs (COP and UYU) are not in future market
Futures require a margin
If you are short a contract, and the market is in backwardation, are you going to achieve positive or negative roll yield
Negative (yes that is right, negative)
Since you are SHORT the contract, it is negative
What is an over under hedge
It is when the portfolio manager in question can over or under hedge a certain position based on his own views, which means he can earn more money
How would you protect against downside using puts
Protective put
Why would one use OTM puts instead of ATM puts for initiating a protective put
You are PAYING less for those puts. Since they are OTM, they are cheaper, but it means that you are more exposed to some downside risk
What is a seagull spread
It is like a bear spread, but you also sell a call in there too, which is OTM. Meaning you collect more and the total cost of the hedge is reduced, but the upside is more limited
When a call is bought ATM, what is its delta
1
What is a proxy hedge
It is using another currency as a hedge if you cannot access the currency you want. Like if you wanted to hedge the Colombian peso, you could probably just hedge the Bolivarno (Boliviar currency)
THIS ONLY WORKS ON A LONG ONE, SHORT THE OTHER SITUATION
Explain minimum variance hedge ratio
Is is when you regress your returns against that of the derivative instrivument to reduce variance or volatiltiy
Why is it hard to deal in EM currencies
Low liquidity
High BS spread
Less pairs
Non normal distribution
Is a EM currency ussually in backwardation or contango
Backwardation - high interest rates
