Minimum Variance hedge ratio

CFA Level III Derivatives
#1

CFAI book 5 page 276-7 Example 9 says:

“Padma Bhattathiri works at Malabar Coast Capital, an India-based invest- ment company. Her mandate is to seek out any alpha opportunities in global FX markets and aggressively manage these for speculative profit. The Reserve Bank of New Zealand (RBNZ) is New Zealand’s central bank, and is scheduled to announce its policy rate decision within the week. The consensus forecast among economists is that the RBNZ will leave rates unchanged, but Bhattathiri believes that the RBNZ will surprise the markets with a rate hike.”

"Given her market view, Bhattathiri would most likely choose which of the following long positions? A 5-delta put option on NZD/AUD

B 10-delta put option on USD/NZD

C Put spread on JPY/NZD using 10-delta and 25-delta options"

Answer is “A is correct. The surprise rate hike should cause the NZD to appreciate against most currencies. This appreciation would mean a depreciation of the NZD/AUD rate, which a put option can profit from.”

What I am confused about is that when there is rate hike, the currency is supposed to depreciate- right? Here they say the other way around. ??? Can anybody clear my confusion?

Thanks- appreciated.

#2

An exogenous ( unexpected ) increase in interest rates translates into a boost of the currency. Believe me, USD/NZD jumps like a rocket only seconds after the rate hike annoucement. Later on, long-term, the currency will want to tend to depreciate as market players start placing their bets and hedges. High interest rate currencies, in theory, will depreciate in value by the interest rate differential of the opposing currency… assuming interest rate parity holds.

#3

So that will be temporary effect? Take advantage of that?

#4

Well it’s not really a temporary effect. It’s more of an immediate effect. And that’s what the question is asking.

#5

Thanks for clearing that up.

#6

Sounds likethe name of a heavy metal rock band that has one top 100 song.