R19 - Example6 (Currency, Risk Reversal)

CFA Level III
#1

I thought I understand risk reversal now but I’m not sure if I understand example 6…

Q: The best method for Brixworth & St. Ives to gain some upside potential for the hedge on the Aggressive Growth Fund’s MXN exposure using MXN/GBP options is to replace the forward contract with a:

A. long position in an OTM put.

B. short position in an ATM call. C. long position in a 25-delta risk reversal. My thought: Want to gain some upside means if MXN appreciated, they can take advantage of it. Sell MXN call at higher strike (to lower the cost but limited the upside) and buy MXN put at lower strike to gain some protection. So Buy MXN collar agn GBP = BUY GBP risk reversal agn MXN => C Is my understnading correct?

#2

If you are a UK-based co and you are exposed to MXN if the MXN appreciates (means MXN/ GBP goes up) you lose money therefore you

can hedge with a long call…

A : long put doesn’t protect you from a higher MXN ;

B : if you a write an OTM call means you void your current ATM long call leaving again the MXN exposure unhedged;

C : Risk Reversal means Short put - Long Call 25-delta away from ATM, it’s good.