Refering to CFAI Text Vol 5, P.315~318 & 2011 CFAI Mock Exam Q18 Can anyone advise what is the definition of Strategic Benchmark Hedge Ratio ?
Anyone ?
Strategic Benchmark Hedge Ratio defines the amount of hedging needed to cover the risk of adverse currency movements . It sis based on expected performance of foreign investments and expectations of currency movements.
ht+he=1+cov/var ht = translation exposure (always hedge 100% for translation risk) he = economic exposure sum of the two is total hedge ratio.
Why it is called “Strategic Benchmark” Hedge Ratio ? I can not find it’s definition in Glossary and I think it is different from that of ht+he=1+cov/var.
Meh, don’t know then.
Can someone explain what to make of the minimum variance hedge? If the hedge ratio = 1.3 we are hedging 100% of the translation risk and 30% for economic risk. whats does 1.3 tell me? To hedge 130% of the initial foreign currency investment? Would anyone ever want to hedge economic but not translation risk?
You can’t look at economic and translation risk separately, there is an interaction between the two, assuming a firm is exposed to both. So what the minimum variance hedge ratio tries to do is solve for the hedge ratio that reduces the variance in exchange rate fluctuation given the relationship between translation and economic risks. Say you’re a Japanese firm that exports to the US, but you purchase inputs from the US. If the USD strengthens, your inputs will increase, but so will your sales since the JPY is weaker. So the two effects naturally hedge each other, although it may not be perfect. Thus, you would want to enter a derivatives contract in order to hedge the residual piece.
It’s exactly the same stuff as ICAPM at L2. Remember the (1 + gamma) business?
CFASniper Wrote: ------------------------------------------------------- > It’s exactly the same stuff as ICAPM at L2. > > Remember the (1 + gamma) business? What is the (1 + gamma) business ?
So i computed my h = 1.1. what does it say? what do i do with it? Also, I’ve seen questions saying “Joe wants to hedge translation risk but not economic”…actually think I saw one saying that the guy wanted to hedge economic but not translation. So seems like I can look at them seperately…
june2009 Wrote: ------------------------------------------------------- > So i computed my h = 1.1. what does it say? what > do i do with it? > > Also, I’ve seen questions saying “Joe wants to > hedge translation risk but not > economic”…actually think I saw one saying that > the guy wanted to hedge economic but not > translation. > > So seems like I can look at them seperately… Okay, but you were referring to the minimum variance hedge ratio, not the unitary hedge ratio.