Currency Strategies | Mind Map

Strategic Decisions

选择hedge或不hedge的原因 (适用PM)

不进行currency management的原因

in the long run currency effects cancel out to zero (mean revert)

link movements in exchange rates, interest rates and inflation rate hold in long-run

an efficient currency market is a zero-sum game

cost will decrease return

适合哪些投资者:very long investment horizon and few immediate liquidity needs

进行currency management的原因

inefficient currency markets and movements could have a dramatic impact on short-term return

适用投资者特点

short term

risk averse

have immediate income or liquidity needs

hedging is cheap

financial markets are volatile

IPS - currency risk management risk policy

target proportion of currency exposure to be passively hedged

latitude for active currency management

frequency of hedge rebalancing

currency hedge performance benchmark

hedging tools permitted

确定optimal weights

portfolio optimization over fully hedged returns

optimize the expected foreign-currency asset risk-return trade-off

selection of active currency exposures

考虑因素

diversification: depend on foreign-currency asset composition

negative correlation

both bonds and currency react strongly to interest rate,little benefit for fixed income portfolios,更需要hedge

global equity portfolio相对不需要hedge

investors

non-US investors: under hedge (<100%)

currencies like USD can act as a safe haven and appreciate in times of market stress

US investors: fully hedge

cost

trading cost

bid-ask spread

currency options: requires the payment of up-front premiums

forward: roll down forward with FX swap, which generate cash inflow or outflow

administrative infrastructure cost and overhead cost

opportunity cost

Strategies

Passive Hedging: keep the portfolio's currency exposures close those of a benchmark portfolio

is a rules-based approach

minimize tracking errors

need periodic rebalancing

Discretionary Hedging

has some limited discretion (percentage of foreign-currency market value) to vary from the neutral position

Active Currency Management (an extension of discretionary hedging)

和完全active比较

no allowance for unlimited speculation

risk management system

和discretionary比较

discretionary的主要目的是protect the portfolio from currency risk;其次是enhance overall portfolio returns

active management的主要目的是take currency risks and manage them for profit (add alpha)

Currency Overlay

一般需要external managers

和 take foreign exchange as an asset class的区别

currency overlay is limited to the currency exposures already in the foreign asset portfolio

foreign currency as asset class is free to take exposures in any currency pair

hedging & alpha function mandates可以拆分

have portfolio fully-hedged but then also add an external currency overlay manager to portfolio

alpha mandates: should have minimum correlation with both the major asset classes and the other alpha sources in the portfolio

可以添加多种overlay strategies

several currency overlay managers with different styles

fund-of-funds approach

Tactical Decisions

which FX exposures to accept and mange within these discretionary limits

based on economic fundamentals

in the long-run, real exchange rate will converge to its fair value

in short- to medium-term, influenced by factors

interest rate

inflation

market risk premium

based on technical analysis

in a liquid, freely traded market the historical price data can be helpful in projecting future price movements

historical patterns have a tendency to repeat

technical analysis does not attempt to determine where market prices should trade but will trade

identify market trend and turning points

based on carry trade

borrow in low-yield currencies and invest in high-yield currencies

carry trade是violation of uncovered interest rate parity

uncovered interest rate parity

yield spread advantage for high-yielding currency is offset by depreciation of the high-yield currency

策略：buy high-yield currency & sell low-yield currency

forward rate bias

Forward rate should be an unbiased predictor of future spot rates

forward premium: >0, overstates the amount of appreciation of the base currency

sell

forward discount:<0, overstates the amount of depreciation

buy

covered interest rate parity

if base currency has a lower interest rate than price currency, forward premium

sell

if base currency has a higher interest rate than price currency, forward discount

buy

return distribution has a pronounced negative skew

funding currencies are typically the safe haven currencies and investment currencies are typically currencies perceived to be higher risk

Tools

forward

forward比futures好的原因

forwards can be customized

futures might not be available for less liquid currencies

futures require up-front margin or additional variation margin, therefore need careful monitoring

forward contracts are more liquid than futures for trading in large sizes

hedge类型

static hedge

will avoid transaction costs but will tend to accumulate unwanted currency risk

dynamic hedge

need periodical rebalancing

影响rebalancing频率的因素

degree of risk aversion

tolerance for active trading

confidence in a particular market view

roll yield

positive: buy base currency at forward discount or sell it at forward premium

negative: buy base currency at forward premium or sell it at forward discount

roll yield影响hedge ratio

positive, more likely be fully hedged or even over-hedged

negative, lower hedge ratio

roll cost> hedge gain

risk-neutral manager would not hedge

risk-averse manager might still implement the hedge(

FX Swaps

matched swap

spot leg

price on the mid-market spot exchange rate

forward leg

取决于base currency的交易方向，sell -- bid price; buy -- offer price

mismatched swap

spot leg

当forward size更大时，使用forward leg所确定的price

forward leg

取决于base currency的交易方向，sell -- bid price; buy -- offer price

Currency options

remove the opportunity cost

Trading Strategies (cost-reduction measures)

accept some downside risk and forgone some upside profits

forward

based on market view over-/under-hedging

结论：increase hedge ratio if base currency depreciate, decrease hedge ratio if the base currency appreciated

protective put (OTM option)

risk reversal

long a call option + short a put option

long collar = short a risk reversal

put spread

long OTM put option + write deeper-OTM put option

zero costs: alter strike price or notional amounts or both of them

seagull spread

short position (short wings)

long ATM put + write OTM put and OTM call

long position (long wings)

write ATM call + long OTM put and OTM call

Exotic options

are designed to customize the risk exposures of client

knock-in/knock-out options

cheaper

binary options

more expensive but more gain

解题思路

1. identify base currency,使用的derivatives针对base currency

2. identify transaction side

3. 调节strike prices & notional amounts towards a zero-cost structure

EM Currencies Hedge

challenges

higher trading costs (wider bid-offer spreads) than major currencies

increased likelihood of extreme market events and severe illiquidity under stressed market conditions

non-deliverable forwards

cash settled in the non-controlled currency rather than physically settled

amount is converted to non-controlled currency use future spot rate

non-controlled currency is usually USD or some other major currency

credit risk of an NDF is lower

sudden changes in government policy can lead to sharp movements in NDF rate (tail risk)

Multiple Currencies Hedge

cross hedge

move currency risk from one foreign currency to another foreign currency

minimum-variance hedge ratio (optimal ratio)

主旨：minimize the tracking error between the value of the hedged asset and the hedging instrument

公式

basis risk is brought into the portfolio when a direct currency hedge is replaced with an indirect hedge

proxy hedge

remove foreign currency risk by hedging it back to the investor's domestic currency

Volatility Trading

delta heding

hedging away the option position's exposure to price risk of the underlying FX spot rate

straddle

both an ATM put and call

strangle

both an OTM put and call

the cost is cheaper

投资者类型

speculative traders: often want to be net-short volatility

hedgers: be net-long volatility

Foreign Exchange Markets

spot

exchange rate: price currency/ base currency (P/B)

EUR&GBP: EUR is base currency

GBP & other currencies: GBP is base currency

AUD/NZD & Not EUR/ GBP: AUD/NZD is base currency

USD & other currencies: USD is base currency

usually priced out to four decimal places

T+2 settlement

bid & offer price (both based on price currency)

bid price: investor is willing to sell the base currency &the counterparty is willing to buy one unit of the base currency

offer price: investor is willing to buy the base currency & the counterparty is willing to sell one unit of the base currency

forward

quote: based on points, the difference between the forward exchange rate and spot exchange rate

mark-to-market value

步骤

1. Create an equal and offsetting forward position

2. Determine the rate for offsetting forward position

3. Calculate the cash flow at settlement day = (new spot rate - forward rate) × contract size

long position: then appreciate, gain

short position: then depreciate, gain

4. Calculate the PV of cash flow (currency of cash flow and discount rate must match)

FX swap

种类

matched swap: two legs are of equal size, use mid-market spot exchange rate

mismatched swap: one leg can be larger than the other, adjust to spot exchange rate

和currency swap的比较

相同：需要交换principal amount

不同：no interim interest payments and are nearly always of much shorter term

用处：可以用来roll forward contracts

currency option

Influence on asset return & risk

return

one asset

multiple assets

risk

公式

特例：

Add exchange rate risk exposure to the portfolio usually adds to domestic-currency return variance

negative correlations among variables will help reduce the overall portfolio's risk through diversification effects

Rfx is calculated as the change in the directly quoted exchange rate, domestic currency is the price currency