MIS 4500 Chapter Notes - Chapter 40: Basis Risk, Spot Contract, Absolute Return

• School: University of Manitoba
• Department: Management Info. Systems
• Course: MIS 4500
• Professor: Pourang Irani

Document Summary

Minimum-variance hedge ratio: used when foreign currency value of foreign investment reacts systematically to an exchange rate movement: optimal hedge ratio (regression hedge ratio): ; also can be estimated as r* = a + h*rf + error term: translation risk: from translation of value of asset from foreign currency to domestic currency; hedge ratio for translation risk is 1. : minimizing the first term comes from an h of 1: economic risk: when foreign currency value of foreign investment reacts systematically to an exchange rate movement (say when country raises interest rates to fight currency depreciation) Hedge ratio estimated by: hedging total currency risk: both translation risk and economic risk. Influence of the basis: futures and spot exchange rates differ by a basis: basis risk: basis equals interest rate differential, implementing hedging strategies: 1. short-term ks, rolled over at maturity.