Reading 46: Currency Risk Management－LOS i investment, management, statements

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 17: Portfolio Management in a Global Context
Reading 46: Currency Risk Management
LOS i: Compare and contrast the major types of currency management strategies specified in investment policy statements.

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Jill Pope, CFA, manages a large portfolio of international assets for a client. She and the client had agreed upon a well-defined IPS, which specified that Pope was responsible for managing currency exposure as one of the risks of the portfolio. Recently Pope and the client changed the IPS so that they now have hired a separate manager, who is an expert in currency risk, and that manager will be responsible for currency risk. The move that Pope and the client have agreed upon would be best described as moving from:

A) an overlay approach to a balanced mandate approach.

B) a balanced mandate approach to a currency overlay approach.

C) an overlay approach to a separate asset allocation approach.

D) a separate asset allocation approach to an overlay approach.

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Answer and Explanation

There are three primary approaches to managing the currency exposure in an international portfolio.

Balanced Mandate: Under a balanced mandate approach, the investment manager is given total responsibility for managing the portfolio, including managing the currency exposure. The manager follows the guidelines of the investors IPS, which will specify whether the portfolio is to be benchmarked and the degree to which translation risk must be hedged.

Currency overlay: The currency overlay approach still follows the IPS guidelines, but the portfolio manager is not responsible for currency exposure. Instead a separate manager, who is considered an expert in foreign currency management, is hired to manage the currency exposure within the guidelines of the IPS. That is, the portfolio, including the currency exposure, is managed by two managers to adhere to the IPS guidelines.

Separate asset allocation: When currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own, separate guidelines. Effectively, this is a currency play with an absolute return benchmark.

There are three primary approaches to managing the currency exposure in an international portfolio.

Balanced Mandate: Under a balanced mandate approach, the investment manager is given total responsibility for managing the portfolio, including managing the currency exposure. The manager follows the guidelines of the investors IPS, which will specify whether the portfolio is to be benchmarked and the degree to which translation risk must be hedged.

Currency overlay: The currency overlay approach still follows the IPS guidelines, but the portfolio manager is not responsible for currency exposure. Instead a separate manager, who is considered an expert in foreign currency management, is hired to manage the currency exposure within the guidelines of the IPS. That is, the portfolio, including the currency exposure, is managed by two managers to adhere to the IPS guidelines.

Separate asset allocation: When currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own, separate guidelines. Effectively, this is a currency play with an absolute return benchmark.

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Rob Johnson, CFA, manages a large portfolio of international assets for a client. He and the client had agreed upon a well-defined IPS, which specified that an outside expert would manage the currency risk as part of the overall portfolio strategy. Recently Johnson and the client changed the IPS so that the expert manages currency positions using a strategy distinct from the security portfolio and distinct benchmarks. The move that Johnson and the client have agreed upon would be best described as moving from:

A) a separate asset allocation approach to an overlay approach.

B) a balanced mandate approach to a currency overlay approach.

C) an overlay approach to a separate asset allocation approach.

D) an overlay approach to a balanced mandate approach.

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Answer and Explanation

There are three primary approaches to managing the currency exposure in an international portfolio.

Balanced Mandate: Under a balanced mandate approach, the investment manager is given total responsibility for managing the portfolio, including managing the currency exposure. The manager follows the guidelines of the investors IPS, which will specify whether the portfolio is to be benchmarked and the degree to which translation risk must be hedged.

Currency overlay: The currency overlay approach still follows the IPS guidelines, but the portfolio manager is not responsible for currency exposure. Instead a separate manager, who is considered an expert in foreign currency management, is hired to manage the currency exposure within the guidelines of the IPS. That is, the portfolio, including the currency exposure, is managed by two managers to adhere to the IPS guidelines.

Separate asset allocation: When currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own, separate guidelines. Effectively, this is a currency play with an absolute return benchmark.

There are three primary approaches to managing the currency exposure in an international portfolio.

Balanced Mandate: Under a balanced mandate approach, the investment manager is given total responsibility for managing the portfolio, including managing the currency exposure. The manager follows the guidelines of the investors IPS, which will specify whether the portfolio is to be benchmarked and the degree to which translation risk must be hedged.

Currency overlay: The currency overlay approach still follows the IPS guidelines, but the portfolio manager is not responsible for currency exposure. Instead a separate manager, who is considered an expert in foreign currency management, is hired to manage the currency exposure within the guidelines of the IPS. That is, the portfolio, including the currency exposure, is managed by two managers to adhere to the IPS guidelines.

Separate asset allocation: When currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own, separate guidelines. Effectively, this is a currency play with an absolute return benchmark.

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In the management of currency exposure, the one approach that would most likely explicitly include a benchmark for returns on currency positions would be associated with:

A) a separate asset allocation approach.

B) an overlay approach.

C) a balanced mandate approach.

D) a cross-hedge approach.

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Answer and Explanation

There are three primary approaches to managing the currency exposure in an international portfolio.

Balanced Mandate: Under a balanced mandate approach, the investment manager is given total responsibility for managing the portfolio, including managing the currency exposure. The manager follows the guidelines of the investors IPS, which will specify whether the portfolio is to be benchmarked and the degree to which translation risk must be hedged.

Currency overlay: The currency overlay approach still follows the IPS guidelines, but the portfolio manager is not responsible for currency exposure. Instead a separate manager, who is considered an expert in foreign currency management, is hired to manage the currency exposure within the guidelines of the IPS. That is, the portfolio, including the currency exposure, is managed by two managers to adhere to the IPS guidelines.

Separate asset allocation: When currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own, separate guidelines. Effectively, this is a currency play with an absolute return benchmark.

There are three primary approaches to managing the currency exposure in an international portfolio.

Balanced Mandate: Under a balanced mandate approach, the investment manager is given total responsibility for managing the portfolio, including managing the currency exposure. The manager follows the guidelines of the investors IPS, which will specify whether the portfolio is to be benchmarked and the degree to which translation risk must be hedged.

Currency overlay: The currency overlay approach still follows the IPS guidelines, but the portfolio manager is not responsible for currency exposure. Instead a separate manager, who is considered an expert in foreign currency management, is hired to manage the currency exposure within the guidelines of the IPS. That is, the portfolio, including the currency exposure, is managed by two managers to adhere to the IPS guidelines.

Separate asset allocation: When currency is considered a separate asset, it is managed as if it were a totally separate allocation given to a separate manager and managed under its own, separate guidelines. Effectively, this is a currency play with an absolute return benchmark.