Derivatives and Currency Management Flashcards
What is the objective of a active currency management approach?
Take currency risks and manage them for profit with the primary goal of adding alpha to the portfolio through successful trading.
What is the objective of a discretionary hedging approach?
Primarily to protect the portfolio from currency risk. Also to seek alpha within limited bounds.
What is the objective of a passive hedging approach?
Keep currency exposures close to those of a BM.
The strategic currency positioning of a portfolio should be more biased toward a fully-hedged programme the more…
ST the investment objectives, risk averse the client, immediate the liquidity needs, fixed income assets held, cheaply a hedging programme can be implemented, and volatile markets are.
What are two justifications for forwards over futures for currency hedging?
Less expensive and greater liquidity.
What positions create a bull spread?
Buy one option and sell another with a higher strike price.
What positions create a bear spread?
Buy one option and sell another with a lower strike price.
What positions create a long calendar spread?
Buy a long dated option and sell a short dated option.
What is the IV takeaway of a volatility smile?
OTM option IV is higher than ATM option IV.
What is the IV takeaway of a volatility skew?
OTM call IV is lower than ATM and OTM put IV is higher than ATM.
Why is OTM puts IV higher than ATM puts?
Cheaper OTM puts are used by investors to hedge downside risk. Higher demand leads to higher prices and higher IV.
What is a long risk reversal trade?
Buy low IV option and sell high IV option. Net long position so delta hedge it out by selling underlying. Profit from IV correction.
What is the equation to find the notional value of an interest rate swap?
portfolio value × target duration - portfolio duration/swap duration
What is the BPV equation for the number of bond futures contracts required to duration hedge a bond portfolio?
(target BPV - portfolio BPV / CTD BPV) × CF.
where:
portfolio BPV = duration × 0.01% × MV
CTD MV = CTD price / 100 × 100,000
Negative basis in a cross currency basis swap indicates a what for the non-USD lender/USD borrower?
A cost.
What is the equation to find the number of equity futures for needed to hedge a portfolio?
(target β - portfolio β / futures β) × MV / F
What is the equation for the value of a volatility swap at expiry?
variance notional × (realised variance – strike variance)
where:
if given realised and strike volatility, square to get variance.
variance notional = vega notional / 2 × strike volatility
What is the equation for the value of a volatility swap before expiry?
variance notional × PV factor (time passed × realised variance + time remaining × implied variance - strike variance
where:
variance notional = vega notional / 2 × strike volatility
What is the equation for the probability of a change in the Fed Funds Rate?
Effective FF rate implied by futured contract - current FF rate / FF assuming a rate hike - current FF
where:
FF futures contract price = 100 − effective FFE rate
current and expected are the midpoint of the range.
What impact does end of month activity by large IIs have on predicted FF rates?
Increased demand leads to a higher fed futures price and a dip in expected FFE rate.
What is a carry trade?
Borrowing a low yield currency and investing in a high yield currency. Want a stable market.
What is trading the forward rate bias?
Borrowing a currency trading at a forward premium and investing in a currency trading at a forward discount.
When rolling over a matched currency swap contract, what rates are used for the spot and the forward legs?
Spot uses mid-market rate and forward uses the all-in rate.
When rolling over a mismatched currency swap contract, what rates are used for the spot and the forward legs?
Both use the all-in rate.
What is a short seagull spread?
Write an OTM call and OTM put and buy an ATM put.
What is the equation for the minimum variance hedge ratio?
correlation × σD/σFX
σFX is standard deviation of the exchange rate.
What is a collar?
Protective put and a covered call i.e., buy put and underlying and sell call. Sell calls to fund the puts. Exposure is between the two strikes.
What positions do you take in a bond arbitrage trade when the basis is positive?
Profit by selling the basis i.e., selling the bond and buying the futures.
Why are variance swaps good for hedging equity tail risk?
Have a convexity feature where when realized variance increases the positive pay off increases. Vega notional should be equal to potential equity position loss.
How do you replicate a long futures position?
Buy underlying stock and invest in risk-free bond.
What is the equation to find the invoice amount that the short receives from the long in a settled bond futures?
futures settlement price / 100 x CF x contract size
contract size usually = 100,000
What is the equation for the number of bond futures contracts required to duration hedge a bond portfolio that has the CTD as the underlying?
(ΔP / ΔCTD) × CF
Under what condition would you exercise if you bought a payer swaption?
If SFR < new SFR
Under what condition would you exercise if you bought a receiver swaption?
if SFR > new SFR
When does a long FRA position win?
When rates rise.
