Please enable JavaScript.
Coggle requires JavaScript to display documents.
Currency Management (Strategic decisions (IPS will address currency mgmt…
Currency Management
FX effects
Return domestic = (1+Return in foreign) * (1+ FX rate) - 1
2 sources of risk= return in foreign and FX rate (use base is the foreign NOT domestic)
-
Strategic decisions
IPS will address currency mgmt policy
- target proportion of FX exposure to be passive
- active FX mgmt target
- Freq of hedge re-balancing
- hedging tools permitted
Time horizon
- long run belief that FX will mean-revert
- short run are volatile
Asset composition
- asset classes have different correlation with FX
Cost considerations
- Trading costs (bid offer spread, option premiums, admin overhead etc)
- Opportunity costs
Risk spectrum
- Passive -> Discretionary>Active>Speculative (view as another asset class)
-
-
Tools of currency mgmt
100% passive hedge w/ FWDs
- match MV of foreign exposure with equal offset in FWD contract
- FWDs quoted in base currency
- static hedge or dynamic hedge
Roll Yield allows to determine to hedge or not
- Positive roll = FWD>Spot (If our hedge is SHORT => selling at premium)
- Negative roll = incline to hedge (if we short FWDs)
Currency options
- If we long foreign asset => to hedge we LONG PUT (if the base if the foreign, if not we LONG CALL)
-
Hedging multiple currency
- consider correlation between different currencies
Cross hedge/proxy hedge: position is used to hedge the risk exposure in another (long NZD asset, short AUD asset, +ve corr(aud,nzd)
Macro hedge: focus on entire portfolio (gold -> extreme events, Derivative on index)
Minimum variance hedge: how much to hedge?
- Asset to be hedge = hedge ratio * hedging asset
- hedge ratio= Covriance (a,b)/Var of hedging asset
EM Currencies
Challenges
- higher trading costs under normal conditions
- increase prob of extreme mkt conditions and liquidity under stressed markets
Non-deliverable forwards (NDFs)
- cash settled in the non-controlled currency, usually USD (not the EM currency)