Currency Overlay

Inbunden, Engelska, 2003

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Currency overlay is the management of the currency exposure inherent in cross-border institutional investments. Exposure to foreign currencies increases the volatility of their returns, without increasing the returns themselves and academics and consultants recommended that the currency exposure should be stripped out of international portfolios and eliminated as far as practicable. This book provides a comprehensive description of currency overlay, its history and possible future developments and growth, the reason for its emergence, the debates and controversies, the different styles of currency management, and the industry's performance track record. This is a subject of international appeal and is an area of particular growth potential for institutional investors. Coverage includes: The theoretical case for eliminating currency risk in international portfoliosThe interplay between asset returns and currency returns, and the effect of this on hedging decisionsBenchmarks - their construction and strategic roleLeast-cost passive overlayThe structure of the currency market, and its 'inefficiencies'Active overlay stylesActive overlay both restricted and unrestricted (currency alpha)Uses diagrams, charts, tables and explanatory boxes to explain concepts

Produktinformation

Utgivningsdatum2003-09-29
Mått177 x 254 x 25 mm
Vikt680 g
FormatInbunden
SpråkEngelska
SerieWiley Finance Series
Antal sidor320
FörlagJohn Wiley & Sons Inc
ISBN9780470850275

Tillhör följande kategorier

Finansiering inom Ekonomi och Ledarskap
Makroekonomi inom Ekonomi och Ledarskap

NEIL RECORD has spent the majority of his working life as a currency overlay manager. He was educated at Oxford and London Universities, and early in his career worked in the Bank of England as an Economist. In 1983, he founded Record Currency (formerly Treasury) Management, the firm he has Chaired and guided for twenty years. The author has been in the forefront of the development of currency overlay since its inception, and is acknowledged as one of the leading figures in the overlay industry. He has authored numerous articles on currency and related topics, and is an external MBA lecturer at the Judge Institute at Cambridge.

List of boxes xvBiography xviiAcknowledgements xix1 Introduction 11.1 Investment background 21.1.1 Investor instruments 21.1.2 Key investor categories 31.1.3 Defined benefit pensions 51.1.4 Defined contribution pensions 61.1.5 Investors in a currency overlay context 62 The Problem 92.1 Asset and liability valuations, volatility and solvency 92.1.1 Funded pension schemes 92.1.2 Asset valuations 92.1.3 Liability valuations 112.1.4 Liabilities’ discount rate 112.1.5 Frs 17 132.1.6 Ias 19 132.1.7 Summary on assets and liabilities 132.2 History of pension fund cross-border portfolio investing 142.2.1 US 142.2.2 UK 142.3 Currency volatility 152.4 Corporate parallels in cross-border investing 202.4.1 Foreign assets 202.4.2 Foreign debt 202.4.3 Economic impact of corporate currency exposure 213 Currency Hedging 233.1 Instruments available 233.1.1 Foreign debt 233.1.2 Forward contracts 253.1.3 Currency swaps 313.1.4 Currency futures 343.1.5 Currency options 373.2 Option pricing 383.2.1 First principles 393.2.2 Option pricing theory 393.3 The Black–Scholes model 403.3.1 Market assumptions 403.3.2 The model 413.3.3 Understanding option pricing 423.3.4 The role of assumptions in option pricing 463.3.5 Practical implications of assumptions violations 483.4 Currency option pricing history 493.4.1 Lognormality 493.4.2 Monte Carlo models 503.4.3 Costs 503.4.4 Sensitivity 513.5 Interest rates and forward currency rates 513.6 Currency Surprise 533.6.1 What is currency surprise? 533.6.2 Currency surprise calculation 533.6.3 Why not spot returns? 543.6.4 Geometric linking and ‘adding across’ 574 Foreign Exchange Market – History and Structure 614.1 A brief history of the foreign exchange market and how instruments developed 614.1.1 Bretton Woods 614.1.2 Central banks as buffer 614.1.3 Ad hoc foreign exchange market development 624.1.4 Free markets dominate 634.1.5 The euro 644.1.6 Instruments 654.2 Basic structure 654.2.1 Market size 664.2.2 Banks – the market-makers 674.2.3 Customers 674.2.4 Clearing mechanism 694.2.5 Turnover excluding ‘clearing’ 704.3 Customer types 704.3.1 Industrial and commercial companies (ICCs) 704.3.2 Oil and commodity dealers and merchants 714.3.3 Financial institutions (banks and insurance companies) 714.3.4 FX option writers 724.3.5 Investment pool traders in FX (hedge funds, proprietary traders) 724.3.6 Investment managers and currency overlay managers 734.3.7 Central banks 744.4 Physical and regulatory issues 754.4.1 Exchange controls 754.4.2 Taxation 794.4.3 Financial regulation 805 Theory of Currency Hedging of International Portfolios 835.1 Lognormal random walk returns 835.1.1 Measurement 835.1.2 Returns 845.1.3 Volatility 865.1.4 Normally distributed period returns 885.1.5 A simple test 895.1.6 Relevance to currency hedging 895.2 The ‘free lunch’ 905.2.1 Which way up? 915.2.2 Adding ‘moving parts’ 915.2.3 Currency exposure is different 935.2.4 Correlation of asset classes 945.3 Hedging and the efficient frontier 975.3.1 Constructing an optimiser including currency 975.3.2 Optimiser methodology 985.4 Implications of transactions costs 1015.4.1 Expected portfolio added value from passive hedging 1026 Passive Currency Overlay 1056.1 Mechanics 1056.1.1 Original maturity of forward contracts 1056.1.2 Frequency of cash flows 1066.1.3 Currencies to be hedged 1066.1.4 Benchmark or actual asset weights to be hedged? 1086.1.5 Denominator of ‘contribution from hedging’ 1106.1.6 Frequency of asset valuation 1106.2 Rebalancing 1116.2.1 Frequency of rebalancing 1126.2.2 Rebalancing buffer (Y/N? size) 1146.2.3 Buffer – ‘percentage of what?’ 1156.2.4 Delay in rebalancing 1156.2.5 Valuation rates 1166.3 Cash flow 1166.4 Costs 1176.4.1 Direct costs 1186.4.2 Indirect costs 1196.4.3 Summary on costs 1216.5 Postscript on costs – conflict of interest 1227 Currency Overlay Benchmarks 1257.1 What is a currency benchmark? 1257.1.1 Misleading currency attribution 1267.1.2 Benchmark as portfolio 1267.1.3 Benchmark mechanics 1267.2 Investability 1277.2.1 Forward currency prices 1277.2.2 WM/Reuters rates 1287.2.3 Contract rolling 1297.2.4 Scale of contracts 1297.2.5 Rebalancing 1297.2.6 Geometric linking 1297.3 Design 1307.3.1 Asset plus currency overlay methodology 1317.3.2 Special case – monthly benchmark calculation 1327.3.3 Valuation of unmatured contracts 1337.3.4 Benchmark hedge ratio 1337.3.5 Embedded currency plus currency overlay methodology 1337.3.6 Currency overlay only methodology 1347.3.7 Other methodologies 1347.3.8 A currency benchmark with or without asset returns? 1357.3.9 Pricing/costs 1367.3.10 Prices, not interest rates 1367.3.11 Rebalancing 1377.3.12 Original contract maturity 1387.3.13 Constant maturity benchmarks 1387.3.14 Discounting 1397.3.15 Benchmark hedge ratio – strategic considerations 1397.3.16 Currency coverage and denominator calculation 1407.3.17 Underlay 1407.3.18 Benchmark performance 1407.3.19 Benchmark cash flows 1417.4 Current practice 1447.5 Worked examples 1457.5.1 Asset plus currency overlay methodology 1457.5.2 Embedded currency plus currency overlay methodology 1477.5.3 Currency overlay only 1487.6 Tracking error 1487.6.1 Passive hedging 1497.6.2 Summary on tracking error 1558 Overlaying Different Asset Classes 1578.1 Equities 1578.1.1 Correlation – the historical evidence 1578.1.2 Correlation evidence 1588.1.3 Individual currency: equity correlations 1598.1.4 Stability of correlations 1608.1.5 Summary on correlation 1628.1.6 Embedded currency 1628.1.7 Firm level analysis 1628.1.8 Country index equity returns 1678.1.9 International equity correlations 1698.1.10 Volatility reduction – the historical evidence 1708.1.11 Effect of hedging on portfolio risk 1728.1.12 Base-currency-specific graphs 1748.2 Hedge ratios 1778.2.1 Current debate 1778.3 Bonds 1828.3.1 Correlation 1828.3.2 Stability of correlations 1858.3.3 Volatility reduction from hedging bonds – the historical evidence 1878.3.4 International diversification 1878.4 Property 1918.5 Other classes 1919 Is the Currency Market Efficient? 1939.1 Types of inefficiency 1939.2 Making the case for currency market inefficiency 1949.2.1 Cyclical behaviour 1949.2.2 Lack of statistical arbitrage 1949.3 Empirical evidence for medium-term trends 1959.4 Forward rate bias – another inefficiency 1989.4.1 What is the evidence for the FRB? 1999.4.2 Risk premium 1999.4.3 Monetary policy and inflation 2019.4.4 Nominal rate illusion 2029.4.5 Other inefficiencies 2029.5 A successful universe? 2029.5.1 An example of different perspectives in the FX market 2039.6 Summary on evidence for inefficiency 2039.6.1 Weak form efficiency 2039.6.2 Semi-strong form efficiency 2049.6.3 Strong form efficiency 2049.6.4 Transactional efficiency 20410 Active Currency Overlay – Management Styles 20510.1 The problem 20510.2 Modelling and forecasting 20610.2.1 Modelling – Occam’s razor 20610.2.2 Can models work? 20710.2.3 What about active management without models? 20910.2.4 Dealing and practical execution 21010.2.5 Timeliness of inputs 21010.2.6 Judgement and modelling 21110.2.7 Deal execution 21210.3 Active management styles 21210.3.1 Fundamental 21310.3.2 Technical 21910.3.3 Option-based 22910.3.4 Dynamic 23411 Active Currency Overlay – Evidence of Performance 23911.1 Surveys 23911.1.1 Currency overlay performance surveys 23911.1.2 Performance summary 24011.2 Who loses? 24012 Implementing Currency Overlay 24312.1 Summary check-list 24312.1.1 What mandate type? 24312.1.2 For risk-reducing overlay – benchmark hedge ratio 24412.1.3 Investment guidelines – active 24512.1.4 Investment guidelines – passive 24612.1.5 Investment guidelines – alpha 24612.1.6 Bank FX lines 24712.1.7 Bank contract confirmation 24812.1.8 Investment management agreement 24812.1.9 Reporting requirements 24812.1.10 Periodic cash and contract reconciliation 24912.1.11 Bank contract settlement procedures 24912.1.12 Benchmark calculation 24912.1.13 Performance measurement 25012.1.14 Summary check-list 25012.2 Practical questions and answers 25113 Looking Ahead 25313.1 Development of active management styles 25313.1.1 Top-down/bottom-up 25313.1.2 Growth/value 25413.1.3 Contrarian/momentum 25413.1.4 Ethical 25413.1.5 Hedge fund styles 25513.1.6 Summary on styles 25513.2 Natural selection of overlay managers 25613.2.1 Conflict of interest 25713.3 Extending the range of hedging instruments 25813.4 Will inefficiencies grow or shrink? 25813.4.1 Can outperformance by currency overlay managers continue? 259References/Useful Reading 261Appendices 263Appendix1–Boundary conditions for forward arbitrage 263Appendix2–Lognormal returns 267Appendix3–AIMR R○ report 277Appendix4–Sample investment guidelines 285Index 289