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THE SPECULATOR

admin — Mon, 04 Jul 2011 18:07:05 +0000

If the idea of currency hedging is controversial to some, then that of currency speculation is even more so. Currency speculation — that is the trading of currencies with no underlying, attached asset — makes up the vast majority of currency market flow. Given that the currency market provides the liquidity for global trade and investment, it is therefore currency speculation that is providing this liquidity. When looking at the issue of currency speculation, one should immediately dispense with such descriptions of it being a “good” or a “bad” influence and instead focus on what it provides. It is neither a benign nor a malign force. Rather, its sole purpose is to make money. Furthermore, it does not act in a vacuum, but instead represents the market’s response to perceived fundamental changes. Thus, it is a symptom rather than the disease itself, which is usually bad economic policy.
Currency speculators are usually made up of one of three groups — interbank dealers, proprietary dealers, or hedge or total return funds. However, at times, currency overlay managers or corporate Treasurers can also be termed currency speculators if they take positions in the currency markets which have no underlying attached asset.

Trend-Following Strategy

admin — Sat, 02 Jul 2011 18:05:30 +0000

The idea behind this strategy is to go long the currency pair when the price is above a moving average of a given length and to go short the currency pair when it is below. Currency managers can choose different moving averages depending on their trading approach to the benchmark. Lequeux and Acar (1998) showed that to be representative of the various durations followed by investors, an equally weighted portfolio based on three moving averages of length 32, 61 and 117 days may be appropriate. If the spot exchange rate is above all three moving averages,hedge the foreign currency exposure 100%. If above two out of the three, hedge one-third of the position. In all other cases, leaves the position unhedged. Trend-following strategies have shown consistent excess returns over sustained periods of time.

Tracking Error

admin — Wed, 29 Jun 2011 18:04:34 +0000

Just as corporations have to deal with “forecasting error” in terms of the deviation of forecast exchange rates relative to the actual future rate, so investors have to deal with tracking error within their portfolios, which is the return of the portfolio relative to the investment benchmark index being used. A portfolio manager can significantly affect the tracking error of their portfolio by the selection of the currency hedging benchmark. Empirically, it has been found that a 50% or symmetrical currency hedging benchmark generates around 70% of the tracking error of that generated by using a polar of 100% currency hedging benchmark. Put another way, the tracking error of a polar currency hedging benchmark is around 1.41 times that of a 50% hedged benchmark. The advantage of a symmetrical or 50% currency hedged benchmark for a portfolio manager is that it reduces tracking error and it also enables them to participate in both bull and bear currency markets.
Two popular types of active currency management strategy are the differential forward strategy and the trend-following strategy. Both of these strategies have consistently added alpha to a portfolio if followed rigorously and interestingly have also proven to be risk reducing compared to unhedged benchmarks. Thus, they also help to boost significantly the portfolio’s Sharpe ratio.

LOSSES IN EVENT OF DEFAULT

admin — Fri, 19 Jun 2009 11:25:15 +0000

The level of expected losses arising from delinquencies should be viewed as a part of the costs of doing business. Actual losses may be higher or lower. Expected credit losses for individual loans depend on the probability that the loan will become delinquent and the likely level of losses in such an event. It is much harder to estimate the probability of default than likely loss rates on delinquent loans.
Loss rates on delinquent accounts depend on four variables. The actual exposure at the time the account was frozen, the level and quality of collateral, the time taken to resolve the case and other direct costs such as legal fees.