# currency: minimum variance hedge

i think that’s what it’s called. and for some reason i can’t get access to the institute’s site. . is there an errata on the box where they talk about the regression being -.2, which to me is 1.0 and -1.2… they say 1.0 and -.2… but the whole subject is somewhat unclear… i think i know it but the material seems wrong in one case, and very vague in other areas of the subject write-up. thanks in advance!!!.. sorry, don’t have book with me, but currency risk management.

The regression would only give you the output of he I think. ht will always be 1.

didn’t they say the regression was -0.2, meaning ht =1, he =-1.2?. but they say 1.0 and -.2 which doesn’t even add up??

can i get a common man’s explanation from either of you two regarding a minimum variance hedge?

westbruin Wrote: ------------------------------------------------------- > didn’t they say the regression was -0.2, meaning > ht =1, he =-1.2?. but they say 1.0 and -.2 which > doesn’t even add up?? What page are you looking at?

sort of tough… but if i’m an american owning a canadian stock, if C\$ goes down 10%, there are two effects: 1) i lose 10% on the currency on translation, 2) but the canadian stock goes up 4% (for instance) in local currency because it’s more competitive (i.e… higher profits), down 6% in domestic currency sorry, i’m confused beyond that. but here goes. i think the hedge ratio is 60%… the Ht = 1, the He = -.4… so that means i hedge 60% the position??.. the big key is the initial regression, and i think they got it wrong and/or too vague. not totally sure about everything though…

westbruin Wrote: ------------------------------------------------------- > didn’t they say the regression was -0.2, meaning > ht =1, he =-1.2?. but they say 1.0 and -.2 which > doesn’t even add up?? The regression output is He. Is this case it is -0.20 or -20%. Ht is always 1 or 100%. Therefore the minimum variance hedge is 100+(-20%)=80%

mwvt9 Wrote: ------------------------------------------------------- > westbruin Wrote: > -------------------------------------------------- > ----- > > didn’t they say the regression was -0.2, > meaning > > ht =1, he =-1.2?. but they say 1.0 and -.2 > which > > doesn’t even add up?? > > What page are you looking at? page 274, book 5, reading 41 solution to 1… i think there are 2 different regressions you could actually run, but the one they teach is different than the one they show. you could run local or domestic return vs. currency, and the difference is one. but they only teach it the one way, and then go another way in the question… so as i said, they could be right, but it’s vague and different from how they teach (which is never good). the “in other words” part somewhat clarifies, but again as different from preceding page.

ilvino Wrote: ------------------------------------------------------- > can i get a common man’s explanation from either > of you two regarding a minimum variance hedge? When you go to hedge currency risk the basic idea is that you hedge the principal. When there is covariance between the local asset returns and the foreign currency return (economic risk) hedging the principal will not be optimal. Ht represents the principal (or transaction risk) He represents the covariance (economic risk)

beautiful explanation, dubbs.

> The regression output is He. Is this case it is > -0.20 or -20%. > > Ht is always 1 or 100%. Therefore the minimum > variance hedge is 100+(-20%)=80% i did figure that out. but… would you be comfortable on their wording in an exam? i mean what they say is the regression is domestic unhedged vs. currency future return. that regression is local vs. currency future return i can figure that out… but it is different than they teach on the preceding page. they say the regression is versus (He + Ht) again, it’s just inconsistent/vague teaching/wording. and i worry about it for exam.

ilvino Wrote: ------------------------------------------------------- > beautiful explanation, dubbs. yes, basically that’s it… EDIT, sorry referenced wrong quote

i’m heading out… basically you could use their regression to get proper answer but i think they are very lazy in wording… and it’s inconsistent with what they teach (but you can get the right answer). just like credit risk of forward contract, i could never figure out how they do it, so i do it different way which turns out to be exactly the same.

westbruin Wrote: ------------------------------------------------------- > > The regression output is He. Is this case it > is > > -0.20 or -20%. > > > > Ht is always 1 or 100%. Therefore the minimum > > variance hedge is 100+(-20%)=80% > > i did figure that out. but… > > would you be comfortable on their wording in an > exam? i mean what they say is the regression is > domestic unhedged vs. currency future return. that > regression is local vs. currency future return > > i can figure that out… but it is different than > they teach on the preceding page. they say the > regression is versus (He + Ht) > > again, it’s just inconsistent/vague > teaching/wording. and i worry about it for exam. Rd=Rf + currency returns They run the regression of domestic returns on the futures return to understand the covariance of the foreign asset returns and currency returns.

no, i think they’re running regression on local returns. should be running on domestic. the way they teach it the regression coefficient should be 0.8, which is 1 -.2… they’re regression coefficient is -.2, and they are combining that with 1 (which isn’t in the regression) sorry, i have read schweser, not so much CFAI… so it could be schweser teaching. as long as they specify local or domestic unhedged, i’m fine. but i didn’t think that was clear.

obviously it’s too late for me to master this concept - i’m ok accepting skin-deep knowledge.

westbruin Wrote: ------------------------------------------------------- > no, i think they’re running regression on local > returns. should be running on domestic. > > > the way they teach it the regression coefficient > should be 0.8, which is 1 -.2… they’re > regression coefficient is -.2, and they are > combining that with 1 (which isn’t in the > regression) > > sorry, i have read schweser, not so much > CFAI… so it could be schweser teaching. > > as long as they specify local or domestic > unhedged, i’m fine. but i didn’t think that was > clear. I think I see what you are saying, wb. Either way, I don’t think we are going to have to go too deep on the LOSs. As long as we understand the concept we should be good.

Never mind.