Currency Management

Question 1

carry trade

Answer 1

ipc > ibc => long PC, short BC

Question 2

trading the forward rate bias

Answer 2

ipc > ibc => F (PC/BC) > S (PC) > S (BC)
=> Long PC, short BC

Question 3

roll yield

Answer 3

iPC > iBC
=> F (PC/BC) > S (PC/BC)
=> roll yield >0
=> Long PC, short BC

Question 4

Optimization of a multi-currency portfolio of foreign assets

Answer 4

locate the portfolio on the efficient frontier of the trade-off between risk and expected return defined in terms of the investor’s domestic currency.

Question 5

two-step process of handle asset allocation with currency risk

Answer 5

(1) portfolio optimization over fully hedged returns
(2) selection of active currency exposure

Question 6

choice of currency exposure (to decide % hedge of the currrency exposure

Answer 6

(1) Diversification consideration
+ If hold long term -> no need to hedge currency exposure
+ If negative correlation -> no need to hedge
+ If asset is FI -> should hedge
(2) Cost consideration
+ Hedging cost (trading cost, oppotunity cost)
+ Hedge large movement can material affect

Question 7

Currency management strategies

Answer 7

+) Passive hedging -> totally hedge
+) Discretionary hedging : allow for partially currency exposure
+) Active currency management: seek currency risk with profit in mandated risk limit
+) Currency overlay:
*) Internal manager: hedge- External manager: seek alpha
*) Correlation between 2 parts should be low

Question 8

should hedge toward fully in:

Answer 8

+ short term investment
+ portfolio owner is risk averse and regret aversion
+ portfolio has liquidity & income need
+ portfolio has FI
+ hedging cheap
+ financial market volatility
+ The beneficial owners/management oversight committee are skeptical of the expected benefits of active currency management.

Question 9

tactical decision of currency risk exposure invesment

Answer 9

+ Econ. fundamental
+ technical analysis
+ carry trade
+ volatility trading

Question 10

limitation of economic fundatmental of active currency management

Answer 10

+ modeling factor effect fx is dificult
+ modeling equilibrium rate is difficult

Question 11

limitation of technical analysis of active currency management

Answer 11

+ lack formal econ.model
+ subjective judment
+ less useful in trendless market

Question 12

tool of currency hedge related to forward contract

Answer 12

+ stratic hedge (hedge 1 times initial) -> unwanted currency exposure
+ dynamic hedge:
*) if foreign increse -> should increase hedge size
*) if spot rate increase -> should increase hedge size
+ FX swaps:
+ Roll yield
*) For a long position: Roll yield= (𝑆𝑃/𝐵−𝐹𝑃/𝐵)/𝑆𝑃/𝐵
*) For a short position: Roll yield=(𝐹𝑃/𝐵−𝑆𝑃/𝐵)/𝑆𝑃/𝐵

Question 13

short risk reversal

Answer 13

= long colar

Question 14

time decay

Answer 14

Time decay is a measure of the rate of decline in the value of an options contract due to the passage of time

Question 15

domiestic currency return of Portfolio

Answer 15

P𝑅𝐷𝐶=w1 x (1+ RDC1) + w2 x (1+RDC2) - 1

Question 16

domestic currency return of asset class

Answer 16

Rdc = (1+ Rfc) x (1+Rfx)- 1
+ Rdc: Domestic currency return of asset class
+ Rfc: Foreign currency return of asset class
+ Rfx: the percentage change of the foreign currency against the domestic
currency

Question 17

currency overlay program

Answer 17

Definition:
+) Limited: means that the PM has outsourced managing currency exposures to a firm specializing in FX management
+) Broader: hired currency overlay manager to take directional views on future currency movements
Uses:
+) the foreign-currency asset portfolio hedged + add an external currency overlay manager to the portfolio
+) currency overlay program should generate alpha that is UNCORRELATED with both the major asset classes and the other alpha sources in the portfolio

Question 18

carry trade characteristics:

Answer 18

+ involves borrowing in low-yield currencies and investing in high-yield currencies
+ equivalent to trading the forward rate bias
+ is a leveraged position
+ lower volatility is better for a carry trade position (da hoi trong Topic test)

Question 19

Non-deliverable forwards (NDFs)

Answer 19

Why: because some emerging country restrict movement currency move in/out of country (CNY. BRL, RUB) to settle contract -> NDFs
Benefit:
+ lower credit risk
+ tail risk (change gov policy)
+) NDF pricing will reflect the individual supply and demand conditions (and risk premia) in the offshore market

Question 20

risk reversal strategy

Answer 20

buy an OTM put option and write an OTM call option

Question 21

Volatility overlay

Answer 21

actively trading the portfolio’s exposures to movement in currencies’ implied volatility

Question 22

Discretionary hedging appropriate for ?

Answer 22

1. Description:
   hedge for appropriate benchmark, but allow active a little bit
2. Use:
   + A long time horizon for portfolio objectives.
   + Low risk aversion.
   + Concern with regret at missing opportunities to add value through discretionary currency management.
   + Low short-term income and liquidity needs.
   + Little foreign currency bond exposure
   + High hedging costs.
   + Clients who believe in the bene

Question 23

cross hedge (proxy hedge)

Answer 23

refers to hedging with an instrument that is not perfectly correlated with the exposure being hedged
Eg: Hedging the risk of a diversified US Equity with S&P future contract

Question 24

Macro hedge

Answer 24

a type of cross hedge that:
+ addresses portfolio-wide risk factors
rather than
+ the risk of individual portfolio assets

Question 25

minimum-variance hedge ratio (MVHR)

Answer 25

is a mathematical approach to determining the hedge ratio.
+ hedge ratio = beta (slope)

Question 26

50-delta put

Answer 26

put is ATM

Question 27

35-delta put

Answer 27

put is OTM

Question 28

25-delta put

Answer 28

put is OTM

Question 29

delta neutral hedging strategy

Answer 29

strategy make delta = 0. Eg: Stradle

Question 30

strategic decision of hedge currency risk least affected by
A. manager’s market views
B. correlation between asset and currency returns
C. investor’s time horizon, risk aversion, and liquidity needs

Answer 30

A. because market view affect Tactical decision

Question 31

active currency trading strategies

Answer 31

(1) economics fundamentals
(2) technical analysis
(3) carry-trade
(4) volatility trading

Question 32

knock in

Answer 32

An option with a knock-in feature is essentially a vanilla option that is created only when the spot exchange rate touches a pre-specified level

Question 33

knock-out

Answer 33

knock-out option is a vanilla option that ceases to exist when the spot exchange rate touches some pre-specified barrier level.

Question 34

Digital options

Answer 34

Digital options are also called binary options, or all-or-nothing options