academy #6 interest rates, currencies & hedging
DESCRIPTION
Academy #6 Interest rates, currencies & hedging. Get connected to B&R Beurs @. Current News. “Europe’s Central Banks Diverge on Path” -The Wall Street Journal - PowerPoint PPT PresentationTRANSCRIPT
Academy #6Interest rates, currencies & hedging
Get connected to B&R Beurs @1
“Europe’s Central Banks Diverge on Path” -The Wall Street Journal
„For the first time in a long time, you don‘t have to be an optimist to see the glass as half full.“ –Mark Carney Bank of England
„Employing unusually sharp language, the U.S. on Wednesday openly criticized Germany's economic policies and blamed the euro-zone powerhouse for dragging down its neighbors and the rest of the global economy.” -WSJ
2
Current News
3
Current News
4
Current News
5
Current News
6
Current News
2011
Q1
2011
Q2
2011
Q3
2011
Q4
2012
Q1
2012
Q2
2012
Q3
2012
Q4
2013
Q1
2013
Q20
200,000400,000600,000800,000
1,000,0001,200,0001,400,000
Wealth in the EU
GermanyNetherlandsBelgium
Net
Wea
lth
7
Current News
2011Q1 2011Q2 2011Q3 2011Q4 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2
-1,500,000
-1,000,000
-500,000
0
500,000
1,000,000
1,500,000
Wealth in the EU
GermanyNetherlandsBelgiumSpainItalienPortugalGreeceN
et W
ealth
Definition:
“Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.”
8
Hedging
Definition:
“Making an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.”
9
Hedging
10
Hedging Example:
◦ We think Adidas will do better than the market
◦ But we do not want to bet on the overall market
◦ What can we do?
11
Hedging Let’s look at data:
1/3/20
12
1/26/2
012
2/18/2
012
3/12/2
012
4/4/20
12
4/27/2
012
5/20/2
012
6/12/2
012
7/5/20
12
7/28/2
012
8/20/2
012
9/12/2
012
10/5/2
012
10/28
/2012
11/20
/2012
12/13
/2012
1/5/20
13
1/28/2
013
2/20/2
013
3/15/2
013
4/7/20
13
4/30/2
013
5/23/2
013
6/15/2
013
7/8/20
13
7/31/2
013
8/23/2
013
9/15/2
013
10/8/2
013
10/31
/2013
020406080
100120140160180
ADIDASDAX
Let’s look at even more data:
What can we do?
12
Hedging
-0.04 -0.03 -0.02 -0.01 0 0.01 0.02 0.03 0.04 0.05
-0.06
-0.04
-0.02
0
0.02
0.04
0.06
0.08
0.1
f(x) = 0.908655860332166 x + 0.000382277701492846R² = 0.430294183237306
Hedging
ReturnsLinear (Returns)
Dax Return
Addi
das
Reut
rn
13
Hedging Hedged position in Adidas:
1/3/20
12
2/22/2
012
4/12/2
012
6/1/20
12
7/21/2
012
9/9/20
12
10/29
/2012
12/18
/2012
2/6/20
13
3/28/2
013
5/17/2
013
7/6/20
13
8/25/2
013
10/14
/2013
020406080
100120140160180
ADIDASDAXHedged
DAX ADIDAS HedgedReturn 0,000896 0,001196 0,000383σ 0,010663 0,014771 0,011161Sharpe 0,083981 0,080969 0,034288
Currency risk: additional volatility after transforming returns of a foreign investment in our domestic currency compared to returns measured in local currency
14
Foreign currencies as a risk factor
15
Foreign currencies as a risk factor
Volatility in EUR: σDAX,EUR = 23.83% Volatility in CHF: σDAX,CHF = 26.26% Currency Risk : σDAX,EUR - σDAX,CHF = 2.43%
02 03 04 05 06 07 08 09 10 11 1240%
60%
80%
100%
120%
140%
160%
180%
DAX in € Dax in CHFSource: datastream
Currency risk is not the volatility of the FX-rate!
In previous case: σCHF,EUR = 7.22% Why is currency risk lower?
Imperfect correlation between DAX returns in EUR and CHF/EUR FX-returns (0.2)
16
What is currency risk?
17
Currency risk differs among asset classes & currencies (1)
Citigroup WGBI US BIG Barclays UK Gov. Bonds Long
3.7%
8.2%
10.5%
13.8%
in local currency in EUR
Large increase of volatility for bondsSource: datastream, bloomberg1999 -2012
18
Smaller (proportional) increase in volatility Large currency risk for Australian Dollar
Currency risk differs among asset classes & currencies (2)
S&P 500 FTSE 100 MSCI Australia
16.3%15.0%
13.3%
16.5%
19.1% 19.0%
in local currency in EURSource: datastream, bloomberg, yahoo1999-2012
19
Commodities: for EUR-investor negative! Hedge Funds: high currency risk
Currency risk differs among asset classes & currencies (3)
DJ UBS Commodity Index HFRX Global Hedge Fund Index
17.6%
6.4%
15.5%
10.6%
in local currency in EURSource: bloomberg1999-2012
20
Currency risk differs among currencies Safe haven currencies (e.g. USD & JPY) tend
to appreciate when int. stock markets fall May provide a natural hedge
21
Currency risk differs among currencies AUD & CAD tend to depreciate when int.
stock markets fall (pos. correlated) mostly better off hedging them
22
Two approaches in practice1. Hedging according to asset classes:
practitioners‘ approach: hedging foreign bonds but not foreign stocks
easy to implement, but neglects correlations2. Currency Overlay:
Currencies are hedged regarding their correlation with the total portfolio
requires permanent analysis
Currency hedging in a portfolio
23
Currency hedging in a portfolio
Stock A (EUR) Bond B (EUR)
Stock A (EUR) 1 σA,B
Bond B (EUR) 1
Assume a portfolio with two domestic assets
24
Currency hedging in a portfolio
…and now one with two foreign assetsStock A
(USD)Bond B
(JPY)FX
EUR/USDFX
EUR/JPYStock A (USD) 1 σA,B σA,USD σA,JPY
Bond B (JPY) 1 σB,USD σB,JPY
FX EUR/USD 1 σUSD,JPY
FX EUR/JPY) 1
Hedging according to asset classes ignores 3 out of 6 correlations!
25
To hedge or not to hedge? Investing in global stocks as an European
investor
26
bonds pay interest periodically and provide a predictable income stream
to diversify risk
to preserve the capital investment
Why invest in bonds?
27
Bonds ≠ Stocks Limited upside potential
You get the coupon and principal
In case of default Large part of the investment
is lost
Unknown upside potential You can benefit from this
Unknown downside potential Usually lower than in case of a
bond default
Special attention to ratings when buying a bond
28
Credit risk: How likely is that the issuer will actually repay?
Term: How far in the future are the payments?◦ Strongly related to inflation risk and changes in
the key interest rates!
Seniority: What is my payment priority when the company actually defaults or goes out of business
What determines the bonds characteristics?
„Interest rate that sets the current price of the bond equal to all the future cash flows“
So it is the solution to the following eqution:
It is a standardized way to compare prices
29
Yield
Interest rate risk: - captures the effect of changes in the market rate of interest on investment value- affects more the value of bonds- when interest rate rises, bond value (price) falls
30
Interest rate risk
31
Term Structure
USGG2YR INDEX USGG5YR INDEX USGG10YR INDEX0
0.5
1
1.5
2
2.5
3
Yields 13.11.2013
Yields 13.11.2013
32
Term Structure
1/2/20
12
3/6/20
12
5/9/20
12
7/12/2
012
9/14/2
012
11/17
/2012
1/20/2
013
3/25/2
013
5/28/2
013
7/31/2
013
10/3/2
013
0
0.5
1
1.5
2
2.5
3
3.5
USGG10YR INDEXUSGG5YR INDEXUSGG2YR INDEX
Term structure is not constant
Interest rate risk is approximated by duration (the % change in the security price for a 1% change in yield)
Duration can also be seen as the average time until you get the payments
For a zero-coupon bond: duration = maturity
33
Interest rate risk - Bonds (1)
A bond with higher duration is perceived as more risky
Lower coupon -> higher duration
Longer maturity -> higher duration
34
Interest rate risk – Bond (2)
Any Questions?
35
36
Hedging Hedged position in Adidas:
37