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CFA Level 3 > Currency Management > Flashcards

Currency Management Flashcards

1
Q
  • Bid price
  • Offer price
A
  • The bid price is the price, defined in terms of the price currency, at which the counterparty providing a two-sided price quote is willing to buy one unit of the base currency.
  • The offer price is the price, in terms of the price currency, at which that counterparty is willing to sell one unit of the base currency
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2
Q

Calculating the forward rate (using forward points)

A

= spot rate + (number of basis points / 10 000)

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3
Q

Calculating the present value of a mark-to-market currency cash flow

A
  1. Cash flow = (closing rate - original rate) * notional
  2. Present value = cash flow / (1 + annualized LIBOR [number of days / 360])
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4
Q

Domestic-currency return

A
  • RDC is the domestic-currency return (in percent)
  • RFC is the foreign-currency return
  • RFX is the percentage change of the foreign currency against the domestic currency (the price currency must be the domestic currency)
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5
Q

Variance of the domestic-currency return

A
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6
Q

Variance of the domestic-currency returns for the overall foreign asset portfolio

A
  • Each Ri equals the variance of the domestic return σ2(RDC)
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7
Q

Uncovered interest rate parity

A
  • Asserts that, on a longer-term average, the return on an unhedged foreign-currency asset investment will be the same as a domestic-currency investment
  • %ΔSH/L is the percentage change in the SH/L spot exchange rate (the low-yield currency is the base currency)
  • iH is the interest rate on the high-yield currency
  • iL is the interest rate on the low-yield currency
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8
Q

Covered interest rate parity

A
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9
Q

Carry trade and forward rate bias implementation

A
  • Forward premium/discount = FP/B - SP/B
  • Both strategies earn a positive roll yield
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10
Q
  • Currency alpha
  • Currency beta
A
  • Managing the active FX exposure
  • Managing the hedge
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11
Q

Trading the forward rate bias

A

Involves buying currencies selling at a forward discount, and selling currencies trading at a forward premium

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12
Q

Currency management strategies

A
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13
Q

Forward currency premium/discount relation to the yield

A
  • Low-yield currency will trade at a forward premium
  • High-yield currency will trade at a forward discount
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14
Q

Straddle

A

A combination of both an at-the-money (ATM) put and an ATM call. A long straddle buys both of these options. Because their deltas are –0.5 and +0.5, respectively, the net delta of the position is zero; that is, the long straddle is delta neutral

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15
Q

Strangle

A

A position for which a long position is buying out-of-the-money (OTM) puts and calls with the same expiry date and the same degree of being out of the money

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16
Q

Price when rolling matched swaps

A

Is the mid-market rate

17
Q

Ordinary least squares equation

A
  • yt = percentage change in the value of the asset to be hedged
  • xt = percentage change in value of the hedging instrument
  • β = the optimal hedging ratio
18
Q

Minimum-variance hedge ratio

A
19
Q

Collar

A

A long position in a put option and a short position in a call option

20
Q

Risk reversal

A

A long position in a call option and a short position in a put option

21
Q

Seagull spread (short)

A
  • Covered call + put spread
  • Long position + short OTM call + long ATM put + short OTM put
22
Q

Seagull spread (long)

A
  • Protective put + call spread
  • Long position + long OTM call + short ATM call + long OTM put
23
Q
  • Knock-in options
  • Knock-out options
A
  • Created when the price touches a pre-defined level
  • Cease to exist when the price touches a pre-defined level
24
Q

A cross hedge (or proxy hedge)

A

Occurs when a position in one asset (or a derivative based on the asset) is used to hedge the risk exposures of a different asset (or a derivative based on it)

25
Q

Roll yield for currency

A

A positive roll yield results from buying the base currency at a forward discount or selling it at a forward premium. Otherwise, the roll yield is negative (i.e., a positive cost)

26
Q

Currency alpha value for an overlay portfolio

A

Will be positive only if the currency alpha has a low correlation with other asset classes in the portfolio

27
Q

When correlation between foreign currency asset returns and foreign currency is negative

A

There may be no need to hedge all foreign currency exposure because some currency exposure is desirable from a portfolio diversification perspective

28
Q

Basis risk

A

The risk resulting from using a hedging instrument that is imperfectly matched to the investment being hedged

29
Q
  • Passive hedging
  • Discretionary hedging
  • Active currency management
  • Currency overlay
A
  • Currency exposure is kept close to that of a benchmark
  • Currency exposure is kept close to that of a benchmark, but the manager has some discretion regarding currency exposure
  • Active management of risk exposure for currency
  • Active management of risk exposure for currency has been outsourced to a specialized firm
30
Q

Non-Deliverable Forwards (NDFs)

A

Used when capital controls exist and delivery in the controlled currency is limited by the local government. The NDF is cash settle using the non-controlled curreny

31
Q

Cost consideration of hedging

A
  • Trading costs
    • Bid-ask spread
    • Option premium
    • FX swap inflow/outflow create volatility in the organization’s cash account
    • Trading infrastructure
  • Opportunity cost (forgo any possibility of favorable currency move)
32
Q

Is it preferable to hedge an international bond or an international equity currency exposure?

A

Since bonds are less volatile than equities, the currency volatility for bonds is a relatively greater source of risk thank it is for equities. A hedge on the bond currency is therefore prefereable

CFA Level 3 (19 decks)

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