executing a hedge- Currency risk management

CFA Level III Derivatives
#1

CFAI Book 4- currency risk management page 252 blue box example

What does the three month forward point mean? Also, the line in the example ‘She uses the offer-side forward points, and the all-in forward rate for the forwrd leg of the swaps is as follows…’

I am not getting a good grasp of this entire reading and this particular blue box example. Can someone explain what does forward point mean and what does the above quoted sentence mean?

Thanks.

#2

In swaps transactions use mid-market quites. Contrary to forward, futures where we use bid or ask spreads.

FX swap is just rolling your position forward. Eg: you are long (going to buy) EUR forward contract that expires in 2 days and you want to roll in for another month. Thus you sell EUR spot (effectively in 2 days) and go long again EUR for another month. The differences in spot and forward rates are your gains/losses - depending whether you’re long/short price/base currency.

#3

Thanks kobi. That makes sense.

#4

For hedge # 2, it’s using the bid side for both the spot and forward transactions. I do not understand this. T

he first transaction is to close out the short position, so using bid side is right but for the forward, they are selling Euro- how is that they still use the bid side?

I’m confused. Help please.

#5

The mid market quotes are applicable only when the amounts being hedged are equal. If more amount of the base currency being bought / sold, we use the offer / bid side for spot and forward points. Take care to see if a hedge being rolled over has a change in amounts due to change in asset values.

Eg - A forward contract was booked for selling EUR 10000 against USD ( I assume a US based investor) , but on the date of rollover the EUR asset has increased in value to 11,000 EUR. So to close the initial hedge, the trader will buy 10000 EUR, but to roll it over, he will sell EUR 11,000 ; a difference of EUR 1,000 which he now needs to sell in a forward date apart from the initial EUR 10k ( hence the bid side price will be taken ).

Alternately, if the asset depriciated in value, the EUR value would go down, then on the date of rollover, the trader will need to buy EUR 10000 but he will sell only 9000 EUR for a forward date, hence he is buying a net of 1000 Euros, which will need to be priced with the quote on the offer side.

#6

Thanks Rahul.