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Currency risk

Currenry risk is the most important area of risk management

Hedging with futures or forward currency contracts

Futures: Futures and forward contracts

The basic approach: hedging the principal

The direction of a foreign exchange involves the exchange rates of two currencies

The hedge is undertaken at time 0, and we will study to return to a furniture time.

The mount of currency hedging should be adjusted periodically Because if the portfolio currency fluctuates the difference can become significant overlong

Minimum-variance hedge radio: the objective of a currency hedge is to minimize the exposure to exchange raye movement

Ratio: is the size of the short futures position in foreign currency to the size of the currency exposure

​​​​​​Optimal hedhe ratio is called regression hedge ration

Translation risk: comes from the translation of the value of the asset from the foreign currency to the domestic currency

Economic risk comes when the foreign currency value of a foreign investmen reacts systematically to an exchange rate movement

Hedging total currency risk: the objective is yo minimize the overall influence of anexchange rate movement

Basis risk: two factors The spot exchange rate/ the interest rate differential The basis equals the interest rate differential

The relation between futures and spot exchange rates: is the function of the futures contract term

Expected hedged return and the basis The return will differ form portfolio achieved

Three basic contract terms Short-term contracts Contracts with a matching maturity Long-term contracts with a maturity extending beyond the hedging period

Hedging multiple currencies cost Cross-hedges are sometimes used for closely linked currencies

Systematic currency reduces the totalvolatility of the portfolio

Insurising and hedging with options

Markets in some countries sometimes offer revise contracts. They need to understand the position that they have

Hedging strategies

This can combine futures and options

Currency overlay

Balance mandate:

Clientsdelegate to the investment manager the responsability

Currency overlay:

Clients delegate the currency management of the international potfolio

Currency as a separateasset allocation:

The manager of the international portfolio is assumed to be a passive in currency terms