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Mr. Peter F. Christoffersen and Mr. Lorenzo Giorgianni

currencies belonging to the basket. For investors, knowledge of conditional risk and return of a speculative position in the basket is of paramount importance. For monetary authorities, it is crucial as well because short-term capital flows are a function of the risk-adjusted return on basket-hedges. If the risk-adjusted returns are large, managing the size and volatility of capital inflows can present a severe challenge to monetary policy makers. When constructing hedged interest rate arbitrage portfolios for basket currencies, two issues arise: first, how are the