QUESTIONS 19 THROUGH 24 RELATE TO RISK MANAGEMENT SELENA ROBERTS CASE...

3. Determining the most appropriate methodology to use for allocating capital to RX’s derivatives specialist, Paul Rodriguez. Task 1: Analyzing the Risks Associated with the Swami Investment Swami exports lumber and cotton on a global scale. Roberts is particularly interested in Rivia Ltd., a local cotton exporter. A majority of Rivia’s local sales are on credit while 50% of its foreign sales are on credit. Rivia does not believe in credit financing and its assets and supplies are purchased using cash. To hedge it foreign currency exposures, Rivia engages in currency swaps and utilizes currency options traded on informal trading platforms. Swami’s debt to foreign currency reserves is currently 2:1 and the country has a significant level of foreign debt outstanding. Task 2: Analyzing the Impact of the Investment on Portfolio Risk and Return and Determining the Degree/Emphasis of Currency Hedging For her analysis of the impact of the investment on portfolio risk and return, Roberts collects information concerning a hypothetical portfolio held by a U.S. investor. The portfolio’s performance is measured in terms of the Swami Pound (SWP) and the portfolio comprises 40% of the SWP-denominated asset and 60% of the USD denominated asset. The firm has little expertise in managing currency exposures. To ascertain the degree/emphasis of currency hedging, Roberts has devised two alternative strategies: Strategy 1: Select a benchmark which has no foreign exchange exposure and if the manager holds a view concerning the SWP, allow currency exposure to drift Strategy 2: Add alpha to client portfolios by taking currency risks and avoid maintaining neutral currency exposures for extensive time periods. Exhibit 1 Performance of a Hypothetical Portfolio Comprising