5

In a word, yes. That's a correct and valid view to take but, as you'll always find in finance, it really depends on context and the question that you're trying to answer. This is the case in markets but more broadly in business and something that academically minded scientists/engineers struggle often understand and appreciate fully. This boils down to the ...


5

There is only one real world! You would use the measure that best describes all the markets together. Bear in mind that for credit you are really interested in portfolio effects. What is the potential credit risk we could have to a particular name? This depends on all the contracts we have them regardless of currency and they need to be modelled ...


4

The quanto adjustment is required to achieve the martingale property for the discounted payoff after currency transformation. Since you do not require discounted asset values to be martingales for risk measurement you do not need a quanto adjustment. But of course you need to include the distribution of future FX-rates in your modelling (which might be what ...


3

A famous article many years ago was The Free Lunch in Currency Hedging by Andre Perold (1988). It showed that while currency hedging does not change long term returns, it does reduce volatility. Thus, for a mean variance investor, it could be beneficial. This is because FX is not much correlated with equity returns, and thus accepting FX risk adds ...


3

Firstly, your portfolio volatility of 0.74% is the variance, as the vol will be 8.6% relative your equity position. This is the Case 2 below. I will try to give you a derivation that you hopefully can find an intuition for. Your portfolio consists of two assets A basket/collection of equity with a market price $S$ USD per unit of equity. Assume you hold $...


3

For a very nice reference on this matter, I recommend Pykhtin and Zhu’s Guide to Modelling Counterparty Credit Exposure, a short paper that thoroughly defines these concepts. Expected Exposure $EE(t)$ (also known as Expected Positive Exposure) for a trade with value $V(t)$ is given by: $$EE(t)=\mathbb{E}[\max(0,V(t))]$$ It is effectively “what you could ...


3

Whether you should currency hedge or not (from a mean-variance perspective) depends on the relative volatility of the asset and the currency, and on how correlated they are. Consider an investment in a foreign-denominated asset, with a currency hedge of $w$ (where $w=0$ is unhedged, and $w=1$ is fully hedged). If the return of the asset in local currency ...


3

Actually the problem is that the probability of default the second year is conditioned by the default the first year. So you have to multiply 4%*101.21*99%, because 1% of the times it has already defaulted the first year


2

When you enter into a derivative trade, such as a swap, the intial value is zero; as interest rates change the value may become positive or negative. If it is positive and the counterparty defaults you could be out a big sum of money (imagine that you are trading with Lehman Brothers in 2008). The idea of PFE is to estimate at some time in the future the ...


2

A: The hedge fund is being lent bonds as collateral for the cash they are giving out. So, the net exposure to the bank is (cash out minus value of bonds being posted). Hence the answer. B: incorrect. A security trading ‘special’ in repo will have a lower repo rate than a general security. This is because if you want to borrow a particular bond, and ...


2

A hedge fund will generally have three kinds of positions: Cash, Long Positions and Short Positions. You find the value of long positions (VLP) by adding up the dollar values of all long positions. You find the value of short positions (VLS, which will be a negative number) by adding up the dollar values of all short positions. Then the Total Equity is ...


1

the gross dollar exposure is the sum of all absolute values of your dollar exposures. the net dollar exposure is the sum of all the signed values of your dollar exposures. a dollar neutral portfolio has 0 net dollar exposure but has a non-zero gross dollar exposure a zero gross dollar exposure implies your portfolio is actually empty hope this clarifies


1

I am adding on to @noob2 answer -- which, is correct if expressing exposures as a value of the fund's base currency. E.g., Fund XYZ has $1M of short equity exposure. When calculating a portfolios total exposure, should the value of the cash accounts be included? For exposures expressed as a percentage of assets, the denominator of that calculation does ...


1

I assume you are referring to the calculation of Gross Exposure and Net Exposure, which are commonly used by Hedge Funds. These funds typically have long and/or short positions in stocks (hence they are called Long Short Funds); these positions vary over time (and can also be quite different among different funds). The exposure refer to stock exposure and ...


1

So, basically, the answer is no. For capital requirements Basel has three categories: a) Counterparty Credit Risk b) Market Risk c) Operation Risk All RWA calculations are additive. If your hedge is with the same counterparty then it likely offsets a) and b) and possibly c). If your hedge is only a market hedge then it will only offset b) and possibly ...


1

Collateral imperfections: the CVA cover the expected exposure in the event that the counterparty defaults. When the trade is collateralized and subject to variation margin. This exposure will come only from the imperfection of the collateral. Because posting and receiving collateral actually has a cost, usually the collateral agreement will be a threshold ...


1

Credit limit is the maximum amount of credit an institution will extend to the client. it is a maximum risk measure. Exposure at default is a current risk measure. The amount of of credit that is extended to a client at any given time will generally be less than the credit limit. It is more of a current state snapshot of the exposure or risk the ...


1

EAD can also be higher than credit limit because of adding the costs of collection activities, noting that these can take a long time. As you mention, the credit limits will tend to have been maxed out, but also missed payments and accruing interest may have increased the exposure before the point in time at which the default is established (definitional ...


1

From mathematical perspective, EAD is the sum of contingent limit amount multiplied by cash conversion factor and cash and non cash exposures (all type of loans that is already allocated to the client)


1

The short answer is that EAD is different from the credit limit and in many cases would be lower. For example if a corporate credit line is used for working capital purpose, the EAD might be much lower as the borrower would eventually stop using the line.


1

The assumption of 100% delta for an option would give a good upper estimate for the exposure due only to the part of the option exposure that comes from the movements in the underlying price. But for example, imagine you had a portfolio which is long a long dated call and long a long dated put, such that the portfolio is overall delta neutral over a ...


1

Based on the UCITS directives: E = n * c * UL * delta where E denotes Exposure, n = contract size, c= contract sie, UL= underlying price. As you're probably aware from BSmodel, call has >0 delta vs <0 for puts. Hope the explanation merely helps you to grasp the direct correlation between E and delta in a UCITS framework.


1

GMO recently published on this ("The Case for Not Currency Hedging Foreign Equity Investments: A U.S. Investor’s Perspective" 1). The basic take-away is that anytime the company or ETF's underlying fundamentals should have nothing to do with the trading currency, it could make sense to not hedge. Think, in the simple case, of a company that is US domiciled ...


1

There is an interesting relationship between currency hedging and the carry trade. It can be shown that currency hedging will add to returns iff the carry trade is profitable. The two are equivalent if you think it through. So for example in the past 20 years interest rates have been very low in Japan and it has been profitable to borrow in Japan and invest ...


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