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).

andytrader

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

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

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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.

andytrader

Jill Pope, CFA, is a portfolio manager in the United States that will begin managing a portfolio denominated only in Euros. Her supervisor asks her to hedge the portfolio against currency fluctuations using an instrument that will effectively be an insurance policy against downside risk while offering upside potential. To do this, Pope:

A) should take a long position in $/€ forward contracts.

B) should buy put options on the $/€ exchange rate.

C) should sell put options on the $/€ exchange rate.

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Put options offer an insurance type protection. Pope can purchase out-of-the-money put options, for example, which will benefit if the Euro depreciates. If the value $/€ declines, the increase in the put option’s value will compensate Pope for the loss the Euro depreciation causes to the portfolio. If the Euro remains unchanged or appreciates, Pope can allow the puts to expire like an insurance policy that never needed to be used.

andytrader

Compared to options on currencies, futures contracts on currencies offer a:

A) more perfect hedge at a higher initial cost.

B) more perfect hedge at a lower initial cost.

C) less perfect hedge at a lower initial cost.

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Futures have a negligible initial cost and the symmetric payoff of the futures usually offers a more perfect hedge than that offered by a put contract, which has a premium that is an upfront cost.

andytrader

Phil Johnson, CFA, is a portfolio manager in the United States and manages a portfolio denominated in yen. Johnson has been using forward contracts on the yen to hedge this portfolio, but now he is considering using put options. Johnson:

A) may choose to use put options if he wishes to more perfectly hedge his portfolio than was possible with the forward contracts.

B) may choose to use put options if he wishes to allow for upside potential on currency changes while hedging downside risk.

C) may choose put options if he wishes to lower the upfront hedging costs from what he incurred using forward contracts.

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Put options offer the type of benefit described in the answer. They allow the upside potential of a yen appreciation, but there is a cost at the initiation of the hedge not incurred with forward and futures contracts.