Currency Strategy, Second Edition develops new techniques and explains classic tools available for predicting, managing, and optimizing fluctuations in the currency markets. Author Callum Henderson shows readers ho to use mathematical models to assist in the prediction of crises and gives practical advice on how to use these and other tools successfully. Given there such huge focus on China at the moment, the timing of this new edition is particularly important. The new edition will feature a thorough update on the key developments in the past 3 years, new chapters on emerging markets, an in-depth review of the markets of China and India and their currencies and much more.

Table of Contents:
Preface to the Second Edition xi Acknowledgements xvii About the Author xix Introduction 1 Part One Theory and Practice 15 1 Fundamental Analysis: The Strengths and Weaknesses of Traditional Exchange Rate Models 17 1.1 Purchasing Power Parity 17 1.1.1 Reasons for “Misalignments” 19 1.1.2 Tradable and Non-Tradable Goods 20 1.1.3 PPP and Corporate Pricing Strategy 20 Example 1 20 Example 2 22 1.1.4 PPP and the Real Exchange Rate 24 1.2 The Monetary Approach 25 1.2.1 Mundell–Fleming 27 1.2.2 Theory vs. Practice 29 1.2.3 A Multi-Polar rather than a Bi-Polar Investment World 30 1.2.4 Two Legs but not Three 30 1.2.5 Implications for New EU Member States 31 1.3 The Interest Rate Approach 32 1.3.1 Real Interest Rate Differentials and Exchange Rates 34 1.4 The Balance of Payments Approach 34 1.4.1 A Fixed Exchange Rate Regime 35 1.4.2 A Floating Exchange Rate Regime 36 1.4.3 The External Balance and the Real Exchange Rate 37 1.4.4 REER and FEER 38 1.4.5 Terms of Trade 39 1.4.6 Productivity 40 1.5 The Portfolio Balance Approach 42 Example 42 1.6 Summary 44 2 Currency Economics: A More Focused Framework 47 2.1 Currencies are Different 48 2.1.1 (In)Efficient Markets 48 2.1.2 Speculation and Exchange Rates: Cause, Effect and the Cycle 49 Example 50 2.1.3 Risk Appetite Indicators and Exchange Rates 53 2.2 Currency Economics 58 2.2.1 The Standard Accounting Identity for Economic Adjustment 58 Example 1 59 Example 2 60 2.2.2 The J-Curve 62 Example 63 2.2.3 The Real Effective Exchange Rate 63 2.3 Summary 64 3 Flow: Tracking the Animal Spirits 65 3.1 Some Examples of Flow Models 69 3.1.1 Short-Term Flow Models 70 3.1.2 Medium-Term Flow Models 77 3.1.3 Option Flow/Sentiment Models 81 3.2 Speculative and Non-Speculative Flows 82 3.3 Summary 84 4 Technical Analysis: The Art of Charting 85 4.1 Origins and Basic Concepts 85 4.2 The Challenge of Technical Analysis 86 4.3 The Art of Charting 87 4.3.1 Currency Order Dynamics and Technical Levels 87 4.3.2 The Study of Trends 90 4.3.3 Psychological Levels 90 4.4 Schools of (Technical) Thought 100 4.5 Technical Analysis and Currency Market Practitioners 102 Part Two Regimes and Crises 105 5 Exchange Rate Regimes: Fixed or Floating? 107 5.1 An Emerging World 108 5.2 A Brief History of Emerging Market Exchange Rates 109 5.2.1 The Rise of Capital Flows 110 5.2.2 Openness to Trade 111 5.3 Fixed and Pegged Exchange Rate Regimes 111 5.3.1 The Currency Board 112 5.3.2 Fear and Floating 112 5.3.3 The Monetary Anchor of Credibility 113 5.4 Exchange Rate Regime Sustainability – A Bi-Polar World? 114 5.5 The Realworld Relevance of the Exchange Rate Regime 116 5.6 Summary 118 6 Model Analysis: Can Currency Crises be Predicted? 119 6.1 A Model for Pegged Exchange Rates 120 6.1.1 Phase I: Capital Inflows and Real Exchange Rate Appreciation 120 6.1.2 Phase II: The Irresistible Force and the Moveable Object 121 6.1.3 Phase III: The Liquidity Rally 123 6.1.4 Phase IV: The Economy Hits Bottom 124 6.1.5 Phase V: The Fundamental Rally 125 6.2 A Model for Freely Floating Exchange Rates 128 6.2.1 Phase I: Capital Inflows and Real Exchange Rate Appreciation 128 6.2.2 Phase II: Speculators Join the Crowd – The Local Currency Continues to Rally 128 6.2.3 Phase III: Fundamental Deterioration – The Local Currency Becomes Volatile 129 6.2.4 Phase IV: Speculative Flow Reverses – The Local Currency Collapses 130 6.3 Summary 133 Part Three The Real World of the Currency Market Practitioner 135 7 Managing Currency Risk I – The Corporation: Advanced Approaches to Corporate Treasury FX Strategy 137 7.1 Currency Risk 138 7.2 Types of Currency Risk 140 7.2.1 Transaction Risk 140 7.2.2 Translation Risk 140 Example 141 7.2.3 Economic Risk 142 7.3 Managing Currency Risk 143 7.4 Measuring Currency Risk – VaR and Beyond 143 7.5 Core Principles for Managing Currency Risk 144 7.6 Hedging – Management Reluctance and Internal Methods 145 7.7 Key Operational Controls for Treasury 147 7.8 Tools for Managing Currency Risk 147 7.9 Hedging Strategies 148 7.9.1 Hedging Transaction Risk 148 7.9.2 Hedging the Balance Sheet 150 Example 150 7.9.3 Hedging Economic Exposure 151 7.10 Optimization 152 7.11 Hedging Emerging Market Currency Risk 153 7.12 Benchmarks for Currency Risk Management 153 7.13 Budget Rates 154 7.14 The Corporation and Predicting Exchange Rates 155 7.15 Summary 155 Additional Section for the Second Edition 156 8 Managing Currency Risk II – The Investor: Currency Exposure within the Investment Decision 163 8.1 Investors and Currency Risk 163 8.2 Currency Markets are Different 164 8.3 To Hedge or not to Hedge – That is the Question! 165 8.4 Absolute Returns – Risk Reduction 165 8.4.1 Passive Currency Management 166 8.4.2 Risk Reduction 166 Example 167 8.5 Selecting the Currency Hedging Benchmark 167 Example 168 8.6 Relative Returns – Adding Alpha 169 8.6.1 Active Currency Management 169 8.6.2 Adding “Alpha” 169 8.6.3 Tracking Error 171 8.7 Examples of Active Currency Management Strategies 172 8.7.1 Differential Forward Strategy 172 8.7.2 Trend-Following Strategy 173 Example 173 8.7.3 Optimization of the Carry Trade 175 8.8 Emerging Markets and Currency Hedging 176 8.9 Summary 178 References 178 Additional Section for the Second Edition 179 9 Managing Currency Risk III – The Speculator: Myths, Realities and How to be a Better Currency Speculator 187 9.1 The Speculator – From Benign to Malign 187 9.2 Size Matters 191 9.3 Myths and Realities 191 9.4 The Speculators – Who they are 192 9.4.1 Interbank Dealers 192 9.4.2 Proprietary Dealers 193 9.4.3 “Hedge” Funds 194 9.4.4 Corporate Treasurers 195 9.4.5 Currency Overlay 196 9.5 The Speculators – Why They Do It 197 9.6 The Speculators – What They Do 197 9.6.1 Macro 198 9.6.2 Momentum (and Fellow Travellers) 198 9.6.3 Flow 199 9.6.4 Technical 199 9.7 Currency Speculation – A Guide 199 9.8 Summary 202 Additional Section for the Second Edition 203 10 Applying the Framework 209 10.1 Currency Economics 209 10.2 Flow Analysis 209 10.3 Technical Analysis 210 10.4 Long-Term Valuation 211 10.5 The Signal Grid 211 10.6 Risk Appetite Indicators 211 10.7 Exchange Rate Regimes 212 10.8 Currency Crises and Models 212 10.8.1 CEMC 212 10.8.2 The Speculative Cycle 213 10.9 Managing Currency Risk I – The Corporation 213 10.9.1 Types of Currency Risk 213 10.9.2 Internal Hedging 214 10.9.3 Key Operational Controls for Treasury 214 10.9.4 Optimization 214 10.9.5 Budget Rates 214 10.10 Managing Currency Risk II – The Investor 215 10.10.1 Absolute Returns: Risk Reduction 215 10.10.2 Selecting the Currency Hedging Benchmark 216 10.10.3 Relative Returns: Adding Alpha 216 10.10.4 Tracking Error 217 10.10.5 Differential Forward Strategy 217 10.10.6 Trend-Following Strategy 217 10.10.7 Optimization of the Carry Trade 217 10.11 Managing Currency Risk III – The Speculator 218 10.12 Currency Strategy for Currency Market Practitioners 218 10.12.1 Currency Trading 218 Example 219 10.12.2 Currency Hedging 220 Example 222 10.13 Summary 224 11 Emerging World: New Growth Markets for Global FX 225 11.1 The Growth of Emerging Markets as an Asset Class 225 11.2 Increasing Importance of EM Currencies 227 11.3 Explosive Growth in Asian Currencies 228 11.4 Asian NDF Markets: Growth and Liberalization 230 11.5 Emerging European Currencies 231 11.6 Latin American Currencies 232 11.7 Summary 232 Conclusion 235 Index 239