R18- Currency managment: an intro

Question 1

Explain the quote of currency

Answer 1

Priced currency /Base currency

Question 2

A quote of 0.9790/ 0.9810 CAD/USD has four interpretations, explain:

Answer 2

Ex. 1,25 AUD EUR
Read
Deliver (sell) 1 EUR buy 1,25 AUD
Buy (Receive) 1 EUR sell AUD

Question 3

In the context of obtain the foward price of a currency, explain the fowards points adjustment.

Answer 3

Tips
Bid/Ask
Always I can buy higher and sell lower. Also for understanding sell/ buy signals. Divide by number of decimal points quoted.

Question 4

Explain the mechanism of mark to market transaction for currency foward contract. Also describe steps for calculate.

Answer 4

Besides the foward contract just realized at settlement, is often required/ desirable or required to mark the position to market value. Present value of gain/loss position at setlement.

Question 5

Explain FX swap mecanism

Answer 5

Not a currency swap, is roll over a maturing foward contract into new foward contract. Usually enter in a offseting transaction while enter into a new foward with later date;

Question 6

Describe how options work for currencies

Answer 6

call option on ZAR/GBP read the right to buy x GBP and sell y ZAR

Question 7

Explain the relation of currency options and delta vs. strike price

Answer 7

Question 8

Domestic currency

Answer 8

Currency of the investor

Question 9

Domestic asset

Answer 9

Asset senominated in the investor’s domestic currency

Question 10

F- Domestic currency return (Rdc)

Answer 10

Is the return in domestic currency units considering both foreign currency returns (Rfc) and the percentage change in the value of the foreign currency (Rfx)

Question 12

In context to calculaste the return on investment in foreign currency, explain the return with increase of 5% Port return and a currency that appreciate in 3%

Answer 12

Tips
This calculation always use the foreign currency as base currency

Question 13

F- to calculate return in multiple investments

Answer 13

Is the weighted average of the domestic currency returns

Question 14

F- Calculate the sd for a foreign inv

Answer 14

Base two sources of risk the portfolio risk and the currency vol

Question 15

Explain how the correlation of foreign investment and currency can affect risk

Answer 15

If correlation is positve between those two components the relationship increase risk, otherwise is true

Question 16

F- Explain the case which correlation between fx and foreing inv is zero
tips
result is a simplified formula for vol

Answer 16

Question 17

Explain the arguments for NOT headging the currency risk (3 options)

Answer 17

1) It is best to avoid the time an cost of hedging
2) In the long run, unheged currency are “zero sum game”
3) In the lon run, currencies revert to a theoretical fair value

Question 18

Explain the arguments besides active managment of currency

Answer 18

Fx reacts to international trade transactions and may drive to prices away from their fair value

Question 19

In the context of currency managment strategies, describe discretionary headging

Answer 19

Allow manager to deviates for exemple 5% fron the hedge ratio

Question 20

In the context of currency managment strategies, describe currency overlay

Answer 20

Will treat currency as an asset class and may take position independent of other portifolio assets. Purely seeking currency alpha, not risk redduction.

Question 21

In the context of portifolio hedge, positive correlation between return of the asset and foreign currency ____ (increase/decrease) need for hedge

Answer 21

POSITIVE relationship INCREASE the need of hedge.

Question 22

What’s the cost’s envolved into hedge currency position

Answer 22

Involves an upfront option premium cost. If the option expires out the money, the premium is lost.
Also foward contracts usually has lower time than hedging period, need to be rolled over as they mature swap, bringing vol earlier than maturity of asset hedge.

Question 23

In cotext of active currency managment, involves tatical allocation, describe the economic fundamentals method and describe situations of appreciation in currency (Not ostensive)

Answer 23

Assumes that in the long run currency value always converge to fair value.

Exemples
- More undervalued relative to their fundamental value
- Higher interest rates
- Lower inflation
Otherwise the opposite effect has a depreciation effect.

Question 24

In context of active currency managment, involves tatical allocation, describe the technical analisys principles. Also describe the tools to this analysis

Answer 24

1. Past price data can predict future price movement
2. Faillible human beings react to similar events in similar ways
3. Unnecessary to know what the currency should be worth.

Tools

• Overbought/ oversold
• Support level
• Resistence level
• Moving avg.

Question 25

In context of active currency managment, involves tatical allocation, describe the carry trade strategie. And what is the condition for this transaction be profitable.

Answer 25

Involve borrow in a lower interest rate currency and invest in a higher interest rate currency. It's based on concept of CIRP, if the theory holds, the difference will be the interest rate between the two currencies. This trade will be profitable if fx change is less than interest rate diferential.

Question 26

If covered interest rates theory holds so the ________

Answer 26

Difference between spot and foward curve equals the difference in the periodic interest rates. In that situation the foward rate will be the spot rate at the end, the depreciation/ increase in currency will off set the gain borrowing in a cheaper country and investing in development country.

Question 27

Uncovered interest rate parity assert that_____

Answer 27

Foward exchange rate calculated by covered interest rate parity is unbiased estimate of the spot exchange rate that will exist in the future. If is true the currency with higher interest rate will decrease by amount of the initial interest rate differential.

Question 28

A carry trade favorable from a scenario of ____ (stable/ high) vol and ____ (high/low) return differential

Answer 28

Stable/High

Question 29

Describe why foward contracts are preferred for currency hedging. (In context of currencies)

Answer 29

1) Can be customized, while futures are standardized 2) Are available for almost any currency pair 3) Futures require margin, and can require periodic cash flows 4) Trading volume of fx fowards and swaps dwafs fx futures, providing liquidity. RESUME Cusomized, available, don't require margin and more liquidity

Question 30

In context of currency headging, explain the advantage/ disa of constant headging

Answer 30

1) Shorter term contracts or dynamic headges with more frequent rebalancing tent to increase cost but improve hedge results 2) Higher risk aversion 3) Lower risk aversion and strong manager around the strategic headging policy

Question 31

Explain the concept of roll yield or roll return

Answer 31

Roll yield is a return from the movement of the foward price over time toward the spot price of an asset. Is the profit or loss is the spot price is unchanged.

Question 32

In the context of currencies F- Roll Yield

Answer 32

The diference between the yield differential

Question 33

Describe when a hedge will be executed

Answer 33

When hedge position earn incremental return over unhedged position. Process compare the foward price vs. expectations of manager.

Question 34

Explain a knock-in option/ call

Answer 34

only come into exist if the underlying reaches some prespecified level.

Question 35

Explain the concept of cross hedge

Answer 35

Refers to hedging with instrument that not perfect correllated.

Question 36

Explain the concept of macro hedge

Answer 36

Adresses portiflio wide risk factors rather than risk of oprtifolio individual asset (interest rate risk, credit risk, vol exposures)

Question 37

Explain the concept of minimum variance hedge

Answer 37

Determine hedge ratio, the hedge ration is the beta of past value portifolio. A hedge ratio higher than 1 will increace the vol of overall portifolio, less than 1 will reduce.