R18- Currency managment: an intro Flashcards
Explain the quote of currency
Priced currency /Base currency
A quote of 0.9790/ 0.9810 CAD/USD has four interpretations, explain:
Ex. 1,25 AUD EUR
Read
Deliver (sell) 1 EUR buy 1,25 AUD
Buy (Receive) 1 EUR sell AUD
In the context of obtain the foward price of a currency, explain the fowards points adjustment.
Tips
Bid/Ask
Always I can buy higher and sell lower. Also for understanding sell/ buy signals. Divide by number of decimal points quoted.
Explain the mechanism of mark to market transaction for currency foward contract. Also describe steps for calculate.
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.
Explain FX swap mecanism
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;
Describe how options work for currencies
call option on ZAR/GBP read the right to buy x GBP and sell y ZAR
Explain the relation of currency options and delta vs. strike price
Domestic currency
Currency of the investor
Domestic asset
Asset senominated in the investor’s domestic currency
F- Domestic currency return (Rdc)
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)
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%
Tips
This calculation always use the foreign currency as base currency
F- to calculate return in multiple investments
Is the weighted average of the domestic currency returns
F- Calculate the sd for a foreign inv
Base two sources of risk the portfolio risk and the currency vol
Explain how the correlation of foreign investment and currency can affect risk
If correlation is positve between those two components the relationship increase risk, otherwise is true
F- Explain the case which correlation between fx and foreing inv is zero
tips
result is a simplified formula for vol
Explain the arguments for NOT headging the currency risk (3 options)
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
Explain the arguments besides active managment of currency
Fx reacts to international trade transactions and may drive to prices away from their fair value
In the context of currency managment strategies, describe discretionary headging
Allow manager to deviates for exemple 5% fron the hedge ratio
In the context of currency managment strategies, describe currency overlay
Will treat currency as an asset class and may take position independent of other portifolio assets. Purely seeking currency alpha, not risk redduction.
In the context of portifolio hedge, positive correlation between return of the asset and foreign currency ____ (increase/decrease) need for hedge
POSITIVE relationship INCREASE the need of hedge.
What’s the cost’s envolved into hedge currency position
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.
In cotext of active currency managment, involves tatical allocation, describe the economic fundamentals method and describe situations of appreciation in currency (Not ostensive)
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.
In context of active currency managment, involves tatical allocation, describe the technical analisys principles. Also describe the tools to this analysis
- Past price data can predict future price movement
- Faillible human beings react to similar events in similar ways
- Unnecessary to know what the currency should be worth.
Tools
- Overbought/ oversold
- Support level
- Resistence level
- Moving avg.
In context of active currency managment, involves tatical allocation, describe the carry trade strategie. And what is the condition for this transaction be profitable.
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.
If covered interest rates theory holds so the ________
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.
Uncovered interest rate parity assert that_____
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.
A carry trade favorable from a scenario of ____ (stable/ high) vol and ____ (high/low) return differential
Stable/High
Describe why foward contracts are preferred for currency hedging. (In context of currencies)
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
In context of currency headging, explain the advantage/ disa of constant headging
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
Explain the concept of roll yield or roll return
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.
In the context of currencies
F- Roll Yield
The diference between the yield differential
Describe when a hedge will be executed
When hedge position earn incremental return over unhedged position. Process compare the foward price vs. expectations of manager.
Explain a knock-in option/ call
only come into exist if the underlying reaches some prespecified level.
Explain the concept of cross hedge
Refers to hedging with instrument that not perfect correllated.
Explain the concept of macro hedge
Adresses portiflio wide risk factors rather than risk of oprtifolio individual asset (interest rate risk, credit risk, vol exposures)
Explain the concept of minimum variance hedge
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.
