R18 - Active currency management

Question 1

What four things can discretionary deviations from the benchmark be based on?

Answer 1

1. fundamentals
2. technical rules
3. carry trade
4. volatility trading

Question 2

What are some economic fundamental improvements that can increase currency in short term?

Answer 2

• long term growth expectations increase
• lower relative inflation
• lower inflation
• higher interest rates
• decreasing currency risk premium

Question 3

What are some technical rules for trading currencies?

Answer 3

• past price action predicts future movement
• –mean reversion for overbought/sold currency
• –support/resistance levels
• –short vs long term moving averages

Question 4

How to implement the carry trade:

Answer 4

• borrow and sell (short sell) low interest rate currency at spot market (currency trading at forward premium)
• invest in higher interest rate currency (currency trading at discount)

Question 5

What is the carry trade?

Answer 5

borrow in low interest rate currency, convert to and invest in higher interest rate currency.

Question 6

Interest rate parity formula

Answer 6

Fp/b = Sp/b * [ ( 1+ip ) / ( 1+ib ) ]

Fp/b = current forward rate of p/b
Sp/b = Spot rate
ip/b = periodic interest rate

Question 7

Volatility trading: What is delta hedging?

Answer 7

Taking a delta neutral position.

Delta = measures change in value of an option for change in value of the underlying

Question 8

What does vega refer to?

Answer 8

Refers to how value of option changes when volatility changes

Question 9

Strategies for options trading based on increases in volatility?

Answer 9

Long straddle = bet on increasing volatility; buy at the money calls and puts on currency

Long strangle = buy out of money calls and puts on currency (reduces initial cost and upside)

Question 10

Strategies for options trading based on decreases in volatility?

Answer 10

Short straddle = sell at money calls and puts on currency
Short strangle = sell out of money calls and puts on currency (lower premium inflow and risk)

If vol is expected to be low use carry trade