LOS e: Explain the issues that arise when hedging multiple currencies.

Q1. In managing international, multi-currency portfolios, cross-hedging:

A)   refers to hedging a stock with a bond, but both are denominated in the same currency.

B)   refers to using the forward contracts on one currency to hedge the currency risk of another currency.

C)   is not a technique used in this case.

Q2. One of the problems in hedging the currency risk of a portfolio that has assets in many currencies is:

A)   the negative correlation of each major currency with the value of its corresponding asset.

B)   that they are inherently unhedgable.

C)   some of the currencies in which assets are denominated may not have liquid contracts that can provide adequate hedges.

Q3. Jill Pope, CFA, manages a large multinational portfolio that includes assets denominated in over 20 currencies. Pope is planning to hedge this portfolio for currency risk. Composing:

A)   a hedge with any measurable effectiveness is not possible because of the many currencies.

B)   a perfect hedge is always possible because all currencies have futures markets that can compose hedges for each currency.

C)   a perfect hedge may not be possible, but she may be able to compose an effective hedge with futures on a few major currencies.

LOS e: Explain the issues that arise when hedging multiple currencies. fficeffice" />

Q1. In managing international, multi-currency portfolios, cross-hedging:

A)   refers to hedging a stock with a bond, but both are denominated in the same currency.

B)   refers to using the forward contracts on one currency to hedge the currency risk of another currency.

C)   is not a technique used in this case.

Correct answer is B)

Currency futures and forward contracts are not always actively traded, so hedging the movements in some of the currencies in a multi–currency portfolio may be difficult and inefficient. In these cases it may be desirable to use a cross hedge (i.e., hedge using an actively-traded futures contract on a correlated currency).

Q2. One of the problems in hedging the currency risk of a portfolio that has assets in many currencies is:

A)   the negative correlation of each major currency with the value of its corresponding asset.

B)   that they are inherently unhedgable.

C)   some of the currencies in which assets are denominated may not have liquid contracts that can provide adequate hedges.

Correct answer is C)

Currency futures and forward contracts are not always actively traded, so hedging the movements in some of the currencies in a multi–currency portfolio may be difficult and inefficient. In these cases it may be desirable to use a cross hedge (i.e., hedge using an actively-traded futures contract on a correlated currency).

Q3. Jill Pope, CFA, manages a large multinational portfolio that includes assets denominated in over 20 currencies. Pope is planning to hedge this portfolio for currency risk. Composing:

A)   a hedge with any measurable effectiveness is not possible because of the many currencies.

B)   a perfect hedge is always possible because all currencies have futures markets that can compose hedges for each currency.

C)   a perfect hedge may not be possible, but she may be able to compose an effective hedge with futures on a few major currencies.

Correct answer is C)

Since many currencies do not have actively traded futures markets, the best choice for hedging a portfolio like the one in this problem would be to choose a few contracts on major currencies. To determine the best type and number of contracts, Pope can use a multiple regression of the returns of her portfolio on the futures returns of liquid contracts for a few major currencies.

Thx!