Asset Alliance Corporation
        Leaders in Alternative Investments




        Demystifying Currency Risk


        Ell...
Currency Funds as a Diversifier
       Correlation Matrix of Various Hedge Fund Return Indices
       Currency managers hi...
Currency Managers move the Efficient Frontier


 35%

 30%

 25%

 20%                                                    ...
There are a Wide Range of Currency Strategies
       Managers A to F employ a mix of strategies
       For managers AA to ...
Popular Currency Strategies


 Carry trade
 Cross currency arbitrage
 Currency overlay
 Macroeconomic
   Central bank poli...
Basics of the Carry Trade


                                                               AUD
                      JPY  ...
Exchange Rates Can Have Rapid Violent Moves

        Euro-JPY
                                                            ...
Return Patterns of Carry Trade Strategies
      Profitability of the buy and hold carry trade strategy
      October 2006 ...
Carry Trade Monthly Returns

          Distribution of monthly returns of the buy and hold carry
          strategy Octobe...
Overlay Strategies
               1.7                                  AUD/CND Futures
                           Futures
...
Cross currency trade

                                            USD




                               H F uy




      ...
Disclaimer



 This is the property of Asset Alliance Corporation.
 No disclosure may be made to third parties regarding
 ...
Asset Alliance
The Americas             Europe, Asia Pacific and the Middle East
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Currency Risk Demystified

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Currency Risk Demystified

  1. 1. Asset Alliance Corporation Leaders in Alternative Investments Demystifying Currency Risk Elliot Noma noma@assetalliance.com Hedge Fund Risk Management Nov 13, 2008 New York Asset Alliance Corporation 800 Third Avenue, 22nd Floor New York, NY 10022 P. 212.207.8786 F. 212.207.8785 www.assetalliance.com noma@assetalliance.com
  2. 2. Currency Funds as a Diversifier Correlation Matrix of Various Hedge Fund Return Indices Currency managers historically have had low correlations with other hedge fund strategies, preceded only by short-bias managers. A B C D E F G H I J A Barclay Currency Traders Index 1 0.28 0.17 0.12 0.38 -0.11 0.29 0.24 0.23 0.46 B HFRI ED: Merger Arbitrage Index 0.28 1 0.9 0.65 0.93 -0.79 0.88 0.93 0.96 0.44 C HFRI ED: Distressed/Restructuring Index 0.17 0.9 1 0.85 0.87 -0.62 0.88 0.95 0.97 0.54 D HFRI EH: Equity Market Neutral Index 0.12 0.65 0.85 1 0.6 -0.21 0.8 0.81 0.78 0.67 E HFRI EH: Quantitative Directional 0.38 0.93 0.87 0.6 1 -0.83 0.88 0.93 0.9 0.53 F HFRI EH: Short Bias Index -0.11 -0.79 -0.62 -0.21 -0.83 1 -0.61 -0.7 -0.71 -0.06 G HFRI Emerging Markets (Total) Index 0.29 0.88 0.88 0.8 0.88 -0.61 1 0.97 0.91 0.65 H HFRI Equity Hedge (Total) Index 0.24 0.93 0.95 0.81 0.93 -0.7 0.97 1 0.97 0.6 I HFRI Event-Driven (Total) Index 0.23 0.96 0.97 0.78 0.9 -0.71 0.91 0.97 1 0.51 J HFRI Macro (Total) Index 0.46 0.44 0.54 0.67 0.53 -0.06 0.65 0.6 0.51 1 2 † As of September 30, 2008. Source: HFRI, Barclay Hedge
  3. 3. Currency Managers move the Efficient Frontier 35% 30% 25% 20% HFRI Indices 15% HFRI Indices + Carry FX 10% HFRI Indices + Non-Carry FX 5% HFRI Indices + FX 0% 0% 2% 4% 6% 8% 10% 12% 3 † As of September 30, 2008. Source: HFRI, Barclay Hedge
  4. 4. There are a Wide Range of Currency Strategies Managers A to F employ a mix of strategies For managers AA to HH, carry trades make up a significant part of their investment strategy A B C D E F AA BB CC DD EE FF GG HH A 1 0.62 0.47 0.28 0.23 0.1 0.18 -0 -0.5 -0.4 -0.4 -0.6 -0.8 -0.8 B 0.62 1 0.21 -0.2 0.41 -0.3 0.39 0.47 -0.4 -0.5 -0.3 -0.1 -0.1 -0.5 C 0.47 0.21 1 0.15 0.28 -0.4 -0.1 0.02 -0.3 -0.1 0.01 0.35 -0.3 -0.7 D 0.28 -0.2 0.15 1 -0.1 0.59 -0.1 -0.3 0.08 -0.4 -0 -0.5 -0.4 -0.3 E 0.23 0.41 0.28 -0.1 1 -0.4 -0.3 -0.2 -0 -0.1 -0.2 0.1 -0.2 -0.3 F 0.1 -0.3 -0.4 0.59 -0.4 1 0.32 -0 -0.1 -0.2 0.12 -0.5 0.2 0.19 AA 0.18 0.39 -0.1 -0.1 -0.3 0.32 1 0.8 -0.7 -0 0.32 -0.1 0.35 0.28 BB -0 0.47 0.02 -0.3 -0.2 -0 0.8 1 -0.5 -0.1 0.39 0.37 0.57 0.28 CC -0.5 -0.4 -0.3 0.08 -0 -0.1 -0.7 -0.5 1 0.06 0.23 0.13 0.17 0.23 DD -0.4 -0.5 -0.1 -0.4 -0.1 -0.2 -0 -0.1 0.06 1 0.39 0.31 0.14 0.32 EE -0.4 -0.3 0.01 -0 -0.2 0.12 0.32 0.39 0.23 0.39 1 0.61 0.56 0.41 FF -0.6 -0.1 0.35 -0.5 0.1 -0.5 -0.1 0.37 0.13 0.31 0.61 1 0.68 0.42 GG -0.8 -0.1 -0.3 -0.4 -0.2 -0.2 0.35 0.57 0.17 0.14 0.56 0.68 1 0.91 HH -0.8 -0.5 -0.7 -0.3 -0.3 0.19 0.28 0.28 0.23 0.32 0.41 0.42 0.91 1 4 † As of September 30, 2008. Source: HFRI, Barclay Hedge
  5. 5. Popular Currency Strategies Carry trade Cross currency arbitrage Currency overlay Macroeconomic Central bank policy Trade flows Trend following High frequency trading Volatility trading 5
  6. 6. Basics of the Carry Trade AUD JPY Sell 100 JPY Buy 1.728 AUD Invest in Invest in Australian Japanese Government Treasury Bills Bonds (coupon=.9%) (coupon = 7.5%) 12 months later: Sell 1.8576 AUD Buy JPY (breakeven exchange rate = 1.84) 6 † Source: Bloomberg
  7. 7. Exchange Rates Can Have Rapid Violent Moves Euro-JPY 7/18/2008 169.48 180 160 140 120 10/27/2008 115.93 100 8/5/2005 11/5/2005 2/5/2006 5/5/2006 8/5/2006 11/5/2006 2/5/2007 5/5/2007 8/5/2007 11/5/2007 2/5/2008 5/5/2008 8/5/2008 7 † Source: Bloomberg
  8. 8. Return Patterns of Carry Trade Strategies Profitability of the buy and hold carry trade strategy October 2006 to October 2008 Long Basket Short Basket Currency Weight Currency Weight AUD 25% JPY 50% TRY 25% CHF 50% BRL 25% 140 NZD 25% 130 120 110 100 90 80 10/31/2006 12/31/2006 2/28/2007 4/30/2007 6/30/2007 8/31/2007 10/31/2007 12/31/2007 2/29/2008 4/30/2008 6/30/2008 8/31/2008 10/31/2008 8 † Source: Bloomberg
  9. 9. Carry Trade Monthly Returns Distribution of monthly returns of the buy and hold carry strategy October 2006 to October 2008 6 5 Frequency 4 3 2 1 0 -14% -12% -10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% 9 † Source: Bloomberg
  10. 10. Overlay Strategies 1.7 AUD/CND Futures Futures Roll arb 1.5 Backwardation 1.3 Volatility reduction 1.1 0.9 0.7 Maturity 0.5 Nov-08 Nov-12 Nov-16 Nov-20 Nov-24 Nov-28 Nov-32 Nov-36 10 † Source: Bloomberg
  11. 11. Cross currency trade USD H F uy Se y 1 2C B ll Bu 93 .001 6 7 SD . 56 1 1.1 1 U 50 U S ll JP D Se Y CHF JPY Sell 1.1672 CHF Buy 93.5650 JPY 11 † Source: Bloomberg
  12. 12. Disclaimer This is the property of Asset Alliance Corporation. No disclosure may be made to third parties regarding any information disclosed in this presentation without the prior permission of Asset Alliance Corporation. This document has been provided for educational purposes only. No representation or warranty is made as to the accuracy or completeness of the information contained in this document. 12
  13. 13. Asset Alliance The Americas Europe, Asia Pacific and the Middle East 800 Third Avenue 16 Charles Street New York, NY 10022 Mayfair, London W1J 5DS United States United Kingdom T 212.207.8786 T 44.207.659.2900 F 212.207.8785 F 44.207.659.2901 info@assetalliance.com info@assetalliance-uk.com 13

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