LOS d: Evaluate the choice of contract terms (short, matched, or long term) when establishing a currency hedge.

Q1. A manager plans to the hedge currency risk of a portfolio. The manager will take positions in futures which he plans to close with offsetting contracts at a later date. In choosing among currency futures contracts of various maturities, the manager should recognize that using the strategy of closing contracts with offsetting contracts rather than making delivery is:

A)   not possible with short-term contracts, but it is possible with long-term contracts.

B)   possible with short-term but not long-term contracts.

C)   possible with both short and long-term contracts.

Q2. Bill Chapman, CFA, has been hedging the currency of his portfolio using long-term futures contracts. He uses the futures as part of the strategic allocation of the portfolio. If Chapman were to decide to start using short-term contracts for the same purpose then, compared to the long-term contracts, he would find the short-term contracts:

A)   more liquid and using them less costly with respect to commissions.

B)   less liquid and using them more costly with respect to commissions.

C)   more liquid and using them more costly with respect to commissions.

Q3. A manager wants to hedge the risk of a portfolio that meets a one-time liability in the near future. If the manager wishes to use a hedging instrument that tracks the behavior of the spot exchange rate, then the manager should choose:

A)   short-term forward contracts.

B)   long-term forward contracts.

C)   short-term swap contracts.

LOS d: Evaluate the choice of contract terms (short, matched, or long term) when establishing a currency hedge. fficeffice" />

Q1. A manager plans to the hedge currency risk of a portfolio. The manager will take positions in futures which he plans to close with offsetting contracts at a later date. In choosing among currency futures contracts of various maturities, the manager should recognize that using the strategy of closing contracts with offsetting contracts rather than making delivery is:

A)   not possible with short-term contracts, but it is possible with long-term contracts.

B)   possible with short-term but not long-term contracts.

C)   possible with both short and long-term contracts.

Correct answer is C)

Contracts for any term may be closed by taking an offsetting position on the delivery date.

Q2. Bill Chapman, CFA, has been hedging the currency of his portfolio using long-term futures contracts. He uses the futures as part of the strategic allocation of the portfolio. If Chapman were to decide to start using short-term contracts for the same purpose then, compared to the long-term contracts, he would find the short-term contracts:

A)   more liquid and using them less costly with respect to commissions.

B)   less liquid and using them more costly with respect to commissions.

C)   more liquid and using them more costly with respect to commissions.

Correct answer is C)

Shorter term contracts are more liquid. To hedge for the long-term, the manager will have to roll them over periodically, which will mean more cost in terms of commissions.

Q3. A manager wants to hedge the risk of a portfolio that meets a one-time liability in the near future. If the manager wishes to use a hedging instrument that tracks the behavior of the spot exchange rate, then the manager should choose:

A)   short-term forward contracts.

B)   long-term forward contracts.

C)   short-term swap contracts.

Correct answer is A)

Short-term forward contracts are best suited for this. Swaps are better for companies trying to hedge cash flows.

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