Currency Management: An Introduction — MCQs

NorthBridge Global Fund reports performance in USD but invests in securities and receives cash flows denominated in multiple currencies. Currency manager Priya Shah is reviewing the fund's EUR exposure. Exchange rates are quoted as units of USD, the price currency, per one unit of EUR, the base currency. An increase in the quoted rate therefore represents appreciation of EUR against USD. The fund owns an unhedged EUR-denominated equity portfolio and expects a separate EUR receivable in six months. The receivable is contractually fixed and has no credit uncertainty. Shah's immediate objective for the receivable is to remove the effect of EUR depreciation on its USD value. Because the fund will receive EUR in the future, it is economically long EUR before any hedge is established. Shah can transact at the spot and forward rates implied by the market data in Exhibit 1, with no transaction costs or counterparty default. The six-month interest rates in Exhibit 1 are annualized simple rates and apply for exactly one-half of a year. Shah uses covered interest parity for a USD-per-EUR quotation. Accordingly, the USD interest accumulation factor is associated with the price currency and the EUR accumulation factor with the base currency. She also considers whether a fixed forward conversion is consistent with the fund's objectives. The investment committee subsequently modifies the objective for the receivable. It wants to establish a minimum USD conversion value but retain any benefit if EUR appreciates against USD. The committee is willing to pay an upfront option premium. All currency options under consideration are European and expire when the receivable is collected. A put on EUR with an exercise rate quoted in USD per EUR provides the right to sell EUR and receive USD at the exercise rate. Finally, a dealer proposes a currency swap under which NorthBridge would receive EUR-denominated payments and make USD-denominated payments. The proposal applies to the existing EUR equity portfolio but does not transfer ownership of the equities or alter their local-market returns. Shah must determine whether those swap cash flows offset or reinforce the portfolio's existing currency exposure. Exhibit 1 reports the relevant exposure and market data, and Exhibit 2 lists the available transactions.