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Fundamental Weighting

This weighting scheme uses company characteristics other than market values such as sales, cashflow, book value, and dividends, to weigh securities. By forming weights based on variables considered important (fundamental) for valuation, these indexes seek to weight securities using true values rather than market prices of capitalization and price weighting.

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Which type of index is most likely to serve as a benchmark?

Capitalization-Weighted

aka

Value Weighted

aka

Cap-Weighted

Trading Costs Associated with 100% foreign-currency hedged strategy

  • Maintaining a 100% hedge requires frequent rebalancing. This “Churning” adds to hedging costs.
  • A long position in currency options requires an upfront payment. If the option expires out-of-the-money this is lost.
  • “Rolling” forward contracts forward may require cash to settle, cashflow management costs may increase as interest rates increase.
  • Overhead costs for personnel and technology to administer the currency hedge.

Non-deliverable Forward (NDF)

Similar to regular forward contracts, but for currencies where the government has implemented capital controls. They are cash settled but always in the non-controlled currency of the currency pair.

Premia income

The income from writing (selling) options.

When pricing delta options in the FX market the ____ numerically delta is ____ out of the money and thus ____ to buy.

Smaller delta options are deeper out of the money and cheaper to buy.

10-delta options are always cheaper than 25-delta options.

Normally the delta for a put is between -1 and 0 with -0.5 being ATM (At The Money).

Normally the delta for a call is between 0 and 1 with 0.5 being ATM.

FX traders quote both in absolute terms.

Minimum-Variance Hedge Ratio

A mathematical approach to determine the optimal cross hedging ratio.

Where:

linearEquation

The optional value for the hedge is:

minimumVarianceHedgeRatio

 

Seagull Spread

All option strategies named after birds involve at least three individual options.

The long position is the body of the seagull. It is often an ATM (At The Money)  put to provide downside protection. The two wings are sold (written) and are OTM (Out of The Money) they should be a call above and a put below the current spot price. These partially offset the cost of the hedge.

A risk reversal

In FX markets, having a long position in a call option and a short position in a put option is called a risk reversal.

This is also known as a collar trade.

Most commonly to hedge you buy a put which OTM (Out of the Money) for downside protection and offset the cost of the hedge by selling (writing) a call, this is a short position in a risk reversal.

Variance of the domestic-currency return formula

You will probably need standard deviation so take the square root of this.

domesticCurrencyReturnVariance