ARE THE COMPLIANCE PROCEDURES LISTED IN EXHIBIT 2 IN ADHERENCE...

18. Are the compliance procedures listed in Exhibit 2 in adherence with the recommendations of The

Code?

Risk Management

Record Keeping

A. No

No

B. Yes

No

C. No

Yes

Portfolio Management—Asset Allocation

Question 4

Use the following information to answer the next six questions.

John Guscott, CFA, is a risk analyst working for Superb Asset Management (SAM) and has been asked to

review the currency exposure and hedging techniques employed by several of the international investment

portfolios at the firm. The domestic currency of all of the funds managed by SAM is U.K. Sterling (GBP).

Guscott initially turns his attention to the North American Structured Investment Fund (NASI Fund). This

fund has exposure to only two foreign markets, Canada and the United States, details of which are set out

in Exhibit 1 (assume that all statistics relate to direct quotations to a U.K. investor):

Exhibit 1

Currency Exposure of the NASI Fund

Canada United States

Weight

30%

70%

Foreign asset price volatility

15.2%

17.5%

Exchange rate volatility versus GBP

14.2%

12.8%

Correlation of foreign asset price and

0.4

–0.1

exchange rate

0.8

Correlation of domestic Canadian

returns and domestic U.S. returns

During his research, Guscott meets with Chris Brown, the manager of the Global Equity Income and

Growth Fund (GEIG Fund). During a discussion with the manager of the fund, Guscott makes the

following notes:

“The manager believes that inefficiencies occur in the foreign exchange markets that can be exploited

to generate excess return consistently over the long term. One of the major strategies that we have been

employing successfully over the past few years is exploiting forward rate bias through the carry trade

executed in currency forward markets.”

Chris Brown demonstrates a simple carry trade based on USD/GBP where the spot rate is 1.5050 and

three‐month forward points are –15.

Guscott’s next task is to interview the management of the Emerging Markets Opportunity Fund (EMO

Fund). Due to the potential for serious currency devaluations in emerging markets, the management

team is very strict regarding their currency hedging policy. Despite the high interest rates often seen in

emerging‐market currencies, the fund always employs a 100% hedge of principal upon entering any

foreign asset position and maintain the currency hedge as a static position over the life of the investment.

In this way, management hopes to avoid suffering losses due to currency crises that may occur in the

emerging markets in which they invest.

The management of the EMO Fund asks Guscott for advice with regards to the lowering the costs of

hedging that they are finding excessively high. Guscott investigates options‐based strategies that can help

reduce the cost of enacting currency hedging. They also ask Guscott what is meant by “roll yield” in

forward contracts and how this is likely to affect the return of their forward contract hedge positions.