R17: Currency Management

Question 1

What is domestic currency volatility dependent on?

Answer 1

Variance of Rfc
Variance of Rfx
Correlation between Rfc and Rfx

Question 2

Risk-averse investors that would want passive hedging more likely if?

Answer 2

ST objectives 
Immediate liquidity needs
More FI securities in FC portfolio
Low cost hedging possible
Financial markets volatile
Believe in EMH

Question 3

What are the four tactical approaches? Active currency management based on…

Answer 3

1. Economic fundamental
2. Technical analysis
3. Carry trade
4. Vol trading

Question 4

How can you reduce hedging costs?

Answer 4

Over/under hedge using forwards (profit from market view)

Buy OTM options (cheaper premiums)

Collar (buy OTM puts, sell OTM call - net outlay zero)

Put spread (buy ATM put, sell OTM put - reduce net outlay)

Seagull spread (put spread + collar)

Exotic options (knock in/outs - cheaper)

Question 5

What are the three ways to hedge multiple FCs?

Answer 5

1. Cross hedge (proxy)
2. Macro hedge
3. Min var HR