Contrast active currency approaches that rely on fundamentals-based valuation, technical analysis, carry trades or trading volatility
The idea
Fundamental approaches estimate long-run fair value from purchasing power parity, real interest rate gaps, current account balances and risk premia, buying undervalued currencies and waiting for slow convergence. Technical approaches read price history, trends, moving averages and overbought or oversold signals, assuming crowd behaviour repeats; they suit trending markets and short horizons. The carry trade borrows low-yield currencies and invests in high-yield ones, profiting because uncovered interest parity fails in the short run; gains are steady but negatively skewed, with sharp losses when risk appetite collapses. Volatility trading uses options, often delta-hedged, to back a volatility forecast against implied volatility. Carry and short volatility both suit calm markets and share crash risk.
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Take the free diagnostic →More in Currency Management: An Introduction
- Analyse how exchange rate changes affect the risk and return of a portfolio
- Explain the strategic decisions available in managing currency exposure
- Design a suitable currency management programme in light of market conditions and the portfolio's objectives and constraints
- Explain how shifts in the drivers of active currency strategies alter tactical positioning
- Explain how hedge ratios are adjusted using currency forwards and foreign exchange swaps
- Explain techniques that cut the cost of hedging and alter the risk and return profile of a portfolio holding foreign-currency assets
- Explain the role of minimum-variance hedge ratios, macro-hedges and cross-hedges for portfolios exposed to several foreign currencies
- Explain the difficulties of managing currency exposure in emerging markets