Currency Management -- Blue Blox Eg 5. Page 350

CFA Level III
#1

Little confused about something. Question 3c asks what the roll yield is on the forward contracts maturity date. I understand a roll yield depends on whether you need to BUY or SELL the BASE currency to maintain the hedge. So if we’re buying the Base at a Forward Discount or Selling the Base at a Forward Premium —> Positve Roll Yield

So for Blue Box Example 5C). I can’t figure out from the chart how you know if for the hedge we’re selling or buying at a Forward Premium or discount. I know to hedge in the question we are BUYING THE BASE to Hedge. But dont understand how to tell if we’re buying at a Forward Premium or Discount

How do I do this?

Thanks,

Much appreciated/

#2

If long foreign asset, you sell forward the fx. Here it is mxn so sell 10m pesos.

But quote is reversed ie mxn/£. So sell mxn equiv to buy £. So u r buying mxn/£ exchange.

Now, the quote is forward discount. If you were selling, you could buy ‘low’ – yielding +ve roll yield; however…you are buying, therefore this quote indicates forward premium ie, -ve roll yield.

hope I did not complicate more.

#3

I wanted to know from the numbers.

Initially we are LONG the MXN and therefor Short the GBP. To Implement the HEDGE we would be Short the MXN and Long the GBP.

Initial point are we selling the GBP at a discount which is 20.05

After to implement the hedge are we LONG the GBP at 20.0580 + (900/10000) = 20.1480

From this I’m assuming we’re selling at a forward discount and buying at a forward premium and therefor it’s a negative roll return.

Do these numbers look right? The answer just has the logic

Much appreciated.

#4

  1. We are buying £. If we were to sell, we would use the rate that results in paying more £ in bid/ask

  2. Since we are buying £, use the the forward rate that offers few £ for 10m mxn. That rate is the same as you described.

  3. Now, you are committed to deliver 10m peso after 2mo and recv £496,327.

If the 1m fwd is say 19, you have committed 20/£ when u could have waited and committed to just 19/£ (commitment to recv 526,316) - if you roll forward, you book the loss 30,000£ (Your fwd is expensive vs mkt - Negative roll yield)

if the 1m fwd is say 21, you made a good call, your hedge is in the money, which will allow you cash out the difference £20,000 ie you sell 20 mxn/£ (commitment to rcv 496, 327 and buy 21 mxn/£ 1mo fwd, commitment to rcv £476,190) and book the profit immediately £20,000 (positive roll yield)

Hope this clears up