andytrader

In managing the risk of a portfolio denominated in a foreign currency, which of the following is not a reason for using a minimum-variance hedge over a hedge of the principal strategy? A minimum variance hedge:

A) avoids having to perform a regression analysis with its associated statistical error.

B) uses the covariance of the return on the foreign assets and exchange rate covariance.

C) hedges against uncertainty concerning the return on the foreign assets.

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The purpose of the minimum-variance spread is to hedge the uncertainty of the return of the assets, which will make the final value different from the principal, and the translation risk associated with the exchange rate. The process does rely upon regression analysis and uses the covariance between the foreign assets and exchange rates.

andytrader

An analyst is managing a portfolio denominated in a foreign currency. In her analysis, she estimates that the hedge ratio of the portfolio is equal to one, and she implements the appropriate hedge. She also forecasts that there will be a negative correlation between the interest rate in her country and the interest rate associated with the foreign currency. This relationship of the interest rates:

A) will reduce but not eliminate the basis risk of the hedged position.

B) will introduce basis risk to the hedged position.

C) is unrelated to basis risk.

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Basis is the difference between the spot and futures exchange rates at a point in time. The magnitude of the basis depends upon the spot rate and the interest rate differential between the two economies. Interest rate parity describes the relationship between spot and futures exchange rates and local interest rates:
Hence, if the interest rates move in the opposite direction, then the basis will change.

andytrader

In the hedging of currency risk, the issue of basis risk is:

A) a concern when using futures contracts and not options.

B) not a concern when using either futures contracts or options.

C) a concern when using options and not futures contracts.

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Basis risk is the difference between the forward or futures price and the spot price. The variability of this measure is a source of risk in a futures or forward hedge where the maturity of the derivative is different from the horizon. Basis risk is not an issue in hedging with options.

andytrader

An analyst is managing a portfolio denominated in a foreign currency, and he plans to hold the portfolio one year. The analyst computes the hedge ratio of the portfolio to be equal to one, and he plans to implement the appropriate hedge. Which of the following actions will reduce basis risk?

A) Nothing; since the hedge ratio equals one the basis risk is zero.

B) Taking successive one-month futures contracts for the upcoming year.

C) Taking a futures position that matures in one year.

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An investor must be aware of basis risk anytime a futures hedge will be lifted prior to the futures maturity date. To avoid basis risk the investor would have to match the maturity of the futures contract with the intended holding period.

andytrader

An analyst in Europe manages a portfolio denominated in yen. The hedge ratio for the portfolio is equal to one, but the futures exchange rate is greater than the spot exchange rate, where the exchange rate is Euro/yen. If there is an increase in the European interest rate relative to the Japanese interest rate, then according to interest rate parity:

A) the basis will narrow.

B) the basis will widen.

C) the basis will remain unchanged.

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Thus, an increase in iD relative to iL will widen the basis.

andytrader

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 both short and long-term contracts.

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

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

andytrader

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

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

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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.

andytrader

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

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

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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.

andytrader

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) is not a technique used in this case.

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

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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).

andytrader

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

C) that they are inherently unhedgable.

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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).