Currency Management

Question 1

If i am buying a future or a forward, what does that mean for either receive or delivering a currency

Answer 1

It means you are going to BUY/receive the currency at that price

Question 2

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

Answer 2

you SELL a future contract on the COP.

You are going to deliver 1trillion pesos in 6 months

Question 3

Explain the process of an offsetting transaction. Use a Buy USD example against the EURO

Answer 3

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.

Question 4

Formula for return in domestic terms of a foreign asset?

Answer 4

Return in domestic = Return on asset in foreign market * appreciation of foreign currency

Question 5

I am invested in COP - bought 65,000 shares of Banco Colombia - do i want the COP to go up or down

Answer 5

UP! then when i convert it back into AUD, it is worth more

Question 6

Variance formula for a one asset portfolio

Answer 6

Variance = variance of foriegn currency + Variance of foreign asset =+ 2*SD foreign asset *SD foreign currency * correlation

Question 7

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?

Answer 7

Increase

Question 8

What is passive hedging and one disadvantage

Answer 8

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

Question 9

What is Discrestionary hedging

Answer 9

This is where you can MODERATLEY change the hedging of your portfolio to increase the incremental gains from currency moves

Question 10

What is active hedging? 1 adv and dis adv

Answer 10

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

Question 11

What is currency overlay in risk management

Answer 11

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

Question 12

What is an issue with using forwards in currency hedging

Answer 12

It can increase your cash flow volatility because forwards are shorter term that your investment horizons

Question 13

What are the 4 approaches to TACTICAL currency management

Answer 13

Economic fundamentals
Technical Analysis
Cash and Carry
Volatility trading

Question 14

What is the economic fundamentals way of tactical currency maagement

Answer 14

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

Question 15

What is technical analayis used for in currency management.

Answer 15

Creating alpha.

Assumes histroric is the future and is predictable

Question 16

Carry trade, how to use it in tactical currency management

Answer 16

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)

Question 17

Volatility trading - explain in currency management

Answer 17

It is when you use straddles or strangles to take advantage of volatility in the market

Question 18

Differences in strangle or straddle

Answer 18

Straddle = ATM calls and puts
Strangle = OTM calls and puts - this makes strangles cheaper, but lower upside too

Question 19

Why are forwards preferred in currency management

Answer 19

OTC (customizable)
Some pairs (COP and UYU) are not in future market
Futures require a margin

Question 20

If you are short a contract, and the market is in backwardation, are you going to achieve positive or negative roll yield

Answer 20

Negative (yes that is right, negative)

Since you are SHORT the contract, it is negative

Question 21

What is an over under hedge

Answer 21

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

Question 22

How would you protect against downside using puts

Answer 22

Protective put

Question 23

Why would one use OTM puts instead of ATM puts for initiating a protective put

Answer 23

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

Question 24

What is a seagull spread

Answer 24

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

Question 25

When a call is bought ATM, what is its delta

Answer 25

1

Question 26

What is a proxy hedge

Answer 26

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

Question 27

Explain minimum variance hedge ratio

Answer 27

Is is when you regress your returns against that of the derivative instrivument to reduce variance or volatiltiy

Question 28

Why is it hard to deal in EM currencies

Answer 28

Low liquidity
High BS spread
Less pairs
Non normal distribution

Question 29

Is a EM currency ussually in backwardation or contango

Answer 29

Backwardation - high interest rates