Derivatives【 Reading 35】习题精选 investment, management, one, 2012, currently

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Jack Tarkenton and Gene Bowman are analysts for the firm Salisbury Consultants. Salisbury provides investment and risk management advice to portfolio managers.
One of Salisbury’s largest U.S. clients has taken a position in a German stock portfolio. The value of the position is currently EUR400,000. The client has a one month time horizon and will hedge translation currency risk with a futures contract that has a maturity of three months. The current and projected portfolio values, spot exchange rates, and futures prices are shown in the table below. To illustrate the effect of currency risk on foreign portfolio values, Tarkenton will calculate the hedged and unhedged return in dollars and Euros.

Original portfolio value in EUR	400,000
Original spot exchange rate	$1.02
Original futures price	$0.98
Portfolio value in 1 month in EUR	420,000
Spot exchange rate in 1 month	$1.07
Futures price in 1 month	$1.03

In his presentation to the client, Tarkenton discusses in more detail the hedging of currency risk for foreign investments using foreign currency futures contracts. Describing the basis for foreign currency futures contracts, he states that it is dependent on the covered interest rate parity relationship. Furthermore, Tarkenton states that basis risk is negligible because, unlike commodities such as corn and silver, foreign currency has no storage costs.
Bowman adds that according to his study of equity and currency markets, hedging foreign equity risk is not a simple task because there is a relationship between foreign stock returns and the changes in foreign currencies. For example, Bowman states that if the Swiss franc declines by 10%, then on average Swiss stocks increase by 4%. Bowman states that this relationship is due to the fact that a weaker Swiss franc makes Swiss exports more competitive in world markets.
Tarkenton states that if an investor had a portfolio of equities from several countries, he or she would run the regression below to hedge currency risk. As a result, the h terms in the regression would provide the optimal hedge ratios for hedging currency risk.
R = α + h1F1 + h2F2 + h3F3 + e.Turning their attention to lesser developed countries, Bowman states that investors should pay particular attention to countries with newly liberalized financial markets because there are significant financial changes post liberalization as reflected in the country’s stock market performance and diversification benefits. In particular, he makes the following comments:

Statement #1: After a country is liberalized, stock returns in the country decrease, perhaps due to the previously high returns associated with the announcement of the liberalization.
Statement #2: From a diversification standpoint, the research shows that stock return volatility declines post liberalization in the short run. Unfortunately though, liberalization leads to higher correlations and betas between the liberalized country and world markets.

In Tarkenton’s German stock portfolio example, what is the unhedged return in dollar terms?

A) 5.00%.

B) 5.25%.

C) 10.15%.

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The return on the unhedged portfolio in dollars factors in the beginning and ending spot rates:
The portfolio return in dollars = (€420,000 × $1.07/€) – (€400,000 × $1.02/€) / (€400,000 × $1.02/€) = ($449,400 − $408,000) / $408,000 = 10.15%.
Both the investment in Euro terms and the Euro itself increased in value. The investor benefited from both. (Study Session 14, LOS 35.a)

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In Tarkenton’s German stock portfolio example, what is the hedged return in dollar terms?

A) 15.05%.

B) 5.25%.

C) 5.00%.

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In a hedge of translation currency risk (i.e. a simple hedge of the principal), the manager would hedge the €400,000 principal. The manager shorts the Euro to hedge their long Euro position in the European stock. The loss on the futures contracts in dollars = €400,000 × ($0.98/€ –$1.03/€) = −$20,000.
The profit on the unhedged portfolio in dollars = (€420,000 × $1.07/€) – (€400,000 × $1.02/€) = $449,400-$408,000 = $41,400.
In net, the investor has made a dollar return of (−$20,000 + $41,400) / $408,000 = 5.25%. (Study Session 14, LOS 35.a)

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Regarding Tarkenton’s statement concerning basis risk, Tarkenton is:

A) incorrect because basis is dependent on the purchasing parity relationship.

B) incorrect because basis is dependent on the purchasing parity relationship and because basis risk is not negligible for foreign currency futures contracts.

C) incorrect because basis risk is not negligible for foreign currency futures contracts.

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Tarkenton is incorrect because basis risk is not negligible for foreign currency futures contracts. If interest rate differentials in the home and foreign country change, the difference between the spot rate and futures rate (i.e. the basis) will change. The only way for basis risk to be eliminated is if the interest rate differential is constant or if the investor matches the maturity of the investment horizon with the maturity of the futures contract. In the latter case, the futures price will converge to the spot price at maturity.
Covered interest rate parity states that the difference between the spot rate and the forward or futures price is due to the interest rate differential between the two countries. (Study Session 14, LOS 35.c)

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Given Bowman’s study of the relationship between Swiss stock returns and changes in the Swiss franc, what would be the optimal amount of SF to hedge for an equity portfolio worth SF 500,000 if the investor wished to hedge both translation and economic risk?

A) SF 125,000.

B) SF 500,000.

C) SF 300,000.

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If the investor was only hedging translation risk, the hedged amount would simply be the principal of SF 500,000 (i.e. a hedge ratio of 1.0). However, in Bowman’s calculation, the relationship between Swiss stock returns and the changes in the Swiss franc is -0.40 (4% / −10%). This ratio would hedge economic risk. To hedge both translation risk and economic risk, the hedge ratio is 0.60 (1 − 0.40). Thus 60% of the principal would be hedged, i.e. SF 300,000. (Study Session 14, LOS 35.b)

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Regarding Tarkenton’s regression to provide the optimal hedge ratios, what do the R and F terms represent?

R term

F terms

A) Foreign asset return in local currency terms Changes in foreign currencies

B) Foreign asset return in domestic currency terms Changes in foreign asset factors

C) Foreign asset return in domestic currency terms Changes in foreign currencies

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The R term represents the return on the foreign asset in domestic currency terms (e.g. dollar terms for a U.S. investor) while the F terms represent changes in foreign currency values. The F terms may be the change in foreign currency futures prices or the change in foreign currency spot prices. The h terms in the regression will provide the optimal hedge ratios for determining the amount of currency exposure to hedge. (Study Session 14, LOS 35.e)

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Regarding Bowman’s comments on the financial changes post liberalization, are the comments correct?

Statement 1

Statement 2

A) Yes No

B) No No

C) No Yes

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Statement #1 is correct. When a country’s financial markets are liberalized, stock returns generally increase as investors bid up the prices of equities previously unavailable to them. After liberalization, stock returns subsequently decline, perhaps due to the previously high liberalization returns.
Statement #2 is incorrect. It is true that liberalization leads to higher correlations and betas with world markets. However, the empirical evidence demonstrates that liberalization does not affect the volatility of returns in the short run. (Study Session 12, LOS 30.c)

andytrader

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.

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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 investor’s 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.

andytrader

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) an overlay approach to a separate asset allocation approach.

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

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

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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 investor’s 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.

andytrader

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) an overlay approach.

B) a separate asset allocation approach.

C) a balanced mandate approach.

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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 investor’s 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.

andytrader

Jill Pope, CFA, has been managing a stock portfolio denominated in a foreign currency and has set a particular nominal return goal for the portfolio. She wishes to investigate ways to achieve the goal while lowering the currency risk. Which of the following strategies is most appropriate?

A) Decreasing the duration of the stock portfolio.

B) Increasing the beta of the stock portfolio.

C) Decreasing the beta of the stock portfolio.

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By increasing beta, Pope has increased the risk exposure to the local market factors relative to the currency exposure. Pope will be able to achieve a given return objective with less currency risk. Since it is a stock portfolio, duration is not relevant.

andytrader

When adding exposure to equities in a foreign market to your portfolio, which of the following strategies would offer the lowest amount of currency risk? In:

A) the foreign futures market going short index futures on an index on the foreign market.

B) your domestic futures market going long index futures on an index on the foreign market.

C) your domestic futures market going long index futures on an index on your domestic foreign market.

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You would want to go long futures on the foreign index. You can choose to go long foreign equity index futures and would only have the initial margin committed (i.e., exposed to translation risk). Further, you may find the desired index future traded on a domestic exchange. In that case, currency exposure is totally eliminated, because prices (including margins) are stated in your domestic currency.

andytrader

When adding exposure to equities in a foreign market to your portfolio, which of the following strategies would offer the lowest amount of currency risk? In:

A) the foreign derivatives market going short call options on an index on the foreign market.

B) your domestic derivatives market going long call options on an index on the foreign market.

C) your domestic derivatives market going long call options on an index on your domestic market.

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You would want to go long call options on the foreign index. You can choose to purchase calls on the index and would only have the initial premium committed (i.e., exposed to translation risk). Further, you may find the desired call options traded on your domestic exchange. In this case, translation risk is totally eliminated, because the premiums are stated in your domestic currency.

andytrader

Bill Bender is a currency trader for International Investing Inc. International’s portfolio managers specialize in finding attractive international investments for U.S. investors. Bender reviews these transactions and determines whether to hedge away some of the risk, then takes the appropriate hedging action.
Tonight he will speak to several hundred students taking investment classes at a local college, discussing strategies for hedging currency risk. While eating lunch, he prepares the following talking points:

• Options can be used to both directly and indirectly hedge currency risk. Futures can do the same.
• Direct hedging of the principal with futures allows investors to hedge away risk, but not to participate in any currency gains.
• A minimum-variance hedge is better than a simple hedge because it accounts for translation risk.
• To avoid basis risk, investors should make sure their futures contracts mature at the end of the asset holding period.

The analysts were busy this morning, and upon his return from lunch, Bender had a stack of proposed trades to review.
The first transaction involves a series of long and short equity trades on a variety of foreign markets. While the trades generally wash out market risk, they make no allowance for currency fluctuations. The profit margin on such strategies can be low, so Bender must keep costs to a minimum. Bender creates a strategy to hedge away much of the risk.
Another analyst wants to take long positions in a variety of European small-cap companies. While the analyst is confident that the stocks will deliver returns superior to other European small-caps, he is concerned that decreases in the euro will erode the returns for U.S. investors. The analyst has provided Bender with the following data:

• Portfolio value: €15 million.
• Expected 12-month return: 26%.
• Current exchange rate: $1.56 per euro.
• Expected exchange rate in 12 months: $1.51 per euro.
• Euro put premium: $0.065.
• Delta: -0.58.

To compensate for this problem, Bender decides to use a currency delta hedge.
Bender then reviews another proposed transaction, the purchase of $10 million dollars of municipal-bond issue in Transylvania. The bonds pay 12 percent because the country’s credit rating is fairly weak. But the Transylvania analyst believes a recent regime change should stabilize the government, and the new leaders will take every precaution needed not to default on the bonds. Bender likes the investment, but has no idea what effect the recent coup is likely to have on Trannsylvanian currency, so he decides to fully hedge the principal and returns for the first year of the investment.
One analyst, Helen Carr, has asked for Bender’s assistance with a matter not related to currency hedging. Carr is not satisfied with the returns of her emerging-markets mutual fund. Her returns are not well correlated with the returns of the Europe, Australia, Far East Index.
Bender meets with Carr to discuss the benefits of emerging-market investments in general. Carr said it took several years to convince International Investments of the benefits of emerging-market investing, allowing that company executives put forth some compelling arguments for keeping out of such markets.
After Bender and Carr get to the specifics about how Carr can boost her returns, Bender suggests that she increase her exposure to small-cap emerging-market stocks. He says the purchase of such stocks will have several effects:

• Increasing the portfolio’s return potential without sacrificing liquidity relative to large-cap emerging-markets stocks.
• Decreasing the portfolio’s correlation with the Europe, Australia, Far East Index.
• Making it easier to boost sector diversification relative to large-cap emerging-markets stocks.
• Increasing the research complexity relative to large-cap emerging-markets stocks.

Assuming currency fluctuation and return expectations prove accurate and the price of a put option rises by $0.036 over the next 12 months, how many put options must Bender buy or sell a year from now to hedge the position?

A) Buy 6,724,138 options.

B) Sell 5,028,736 options.

C) Buy 387,931 options.

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To create the currency delta hedge, Bender must purchase the following put options: −1 / delta × portfolio value = 25,862,069 puts. Then we must calculate how many options to buy or sell a year from now. New delta = change in put option value / change in exchange rate = ($0.036) / (−$0.05) = −0.72. −1 / delta × portfolio value = number of options needed to hedge. −1 / −0.72 × €15,000,000 × 1.26 = 26,250,000 puts, or 387,931 more than the current holdings. (Study Session 14, LOS 35.g)

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Which of Bender’s statements about small-cap emerging-markets stocks is least accurate? That they will:

A) decrease the portfolio’s correlation with the Europe, Australia, Far East Index.

B) make it easier to boost sector diversification relative to large-cap emerging-markets stocks.

C) increase the portfolio’s return potential without sacrificing liquidity relative to large-cap emerging-markets stocks.

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Small-cap emerging-markets stocks are likely to boost returns, but they are also considerably less liquid than large-cap emerging-markets stocks. Both remaining statements are accurate. (Study Session 12, LOS 30.b)

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To accomplish his goals regarding the Trannsylvania investment, Bender should:

A) sell $10 million worth of futures contracts.

B) buy $11.2 million worth of futures contracts.

C) sell $11.2 million worth of futures contracts.

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To hedge currency risk on a foreign bond purchase, a trader could sell currency futures. In this case, a $10 million investment should be worth $11.2 million over a year. To fully hedge the principal and returns, Bender must sell futures contracts equal to the value of the principal plus the interest return, or $11.2 million. (Study Session 14, LOS 35.a)

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Which of the following arguments against investing in emerging markets is least convincing?

A) Over most of the last 20 years, annualized returns for emerging markets lagged those of U.S. investments.

B) Over time, the correlation of emerging markets and that of developed markets is likely to increase.

C) Emerging-markets stocks tend to lower returns and boost risk for global portfolios during bull markets in U.S. stocks.

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Emerging-markets stocks tend to lower returns and add risk during U.S. bear markets – they tend to boost returns in bull markets. The other two concerns are legitimate. (Study Session 12, LOS 30.b)

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Which of Bender’s talking points is least accurate?

A) Options can be used to both directly and indirectly hedge currency risk. Futures can do the same.

B) A minimum-variance hedge is better than a simple hedge because it accounts for translation risk.

C) Direct hedging of the principal with futures allows investors to hedge away risk, but not to participate in any currency gains.

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Simple hedges account for translation risk, while a minimum-variance hedge also addresses economic risk. The other statements are accurate. (Study Session 14, LOS 35.b)

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To hedge away the basis risk for the long-short equity investment, Bender’s best option is a strategy:

A) starting with options on the relevant foreign currencies.

B) starting with a regression of U.S. returns of foreign currency futures.

C) hedging the principal.

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To correctly perform a cross-hedge, Bender should start with regression analysis of currency returns. A hedge of the principal won’t address the cross-currency issues. Put options may be an effective hedge, but purchasing that portfolio insurance requires up-front costs. If minimizing costs is key, options are not the answer. (Study Session 14, LOS 35.c)

andytrader

Jill Pope, CFA, is a portfolio manager in the United States and has been using a delta hedge strategy using $/yen put conracts on her 10,000,000 yen security portfolio. The delta is 0.80. Other things equal, in dollar terms, a 0.100% decrease in the $/yen exchange rate would produce a:

A) 0.1% decrease in the security portfolio and a 0.125% increase in each put purchased.

B) 0.1% decrease in the security portfolio and a 0.080% increase in each put purchased.

C) 0.1% increase in the security portfolio and a 0.080% increase in each put purchased.

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The decrease in the $/yen exchange rate will lower the value of the portfolio in dollar terms because each yen will be able to be converted to fewer dollars. The delta of an option is defined as its value change relative to the value change of the underlying. Thus, the options will increase by 0.8 times the percent decline in the $/yen exchange rate.

andytrader

Phil Johnson, CFA, is a portfolio manager in the United States and has been using a delta hedge strategy using $/€ put contracts on his €5,000,000 security portfolio. Johnson estimates the delta of the put contract to be -0.40, and Johnson used this value in composing his delta hedge. The $/€ exchange rate decreases from $1.25/€ to $1.2/€. The price of the put per Euro increases by $0.01. Based on this information, Johnson’s net position would:

A) decline by $375,000.

B) decline by $125,000.

C) increase by $125,000.

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Johnson would have purchased -1 / -0.4 = 2.5 put contracts for each Euro. The value of the portfolio would have declined by $250,000 = (1.25 − 1.2)($/€)(€5,000,000). The value of the put contract position will increase by $125,000 = ($0.01)(5,000,000)(2.5). Thus, the net change is a decline of $125,000.