Currency hedges question

Ireland-based Old Galway Capital runs several investment trusts for its clients. Fiona Doyle has just finished rebalancing the dynamic currency hedge for Overseas Investment Trust III, which has an IPS mandate to be fully hedged using forward contracts. Shortly after the rebalancing, Old Galway receives notice that one of its largest investors in the Overseas Investment Trust III has served notice of a large withdrawal from the fund.


Given the sudden liquidity need announced, Doyle’s best course of action with regard to the currency hedge is to:

  1. do nothing.
  2. reduce the hedge ratio.
  3. over-hedge by using currency options.

Answer is A.

But if they had 3 month forwards and the client wants to withdraw funds in 2 months, wouldn’t they need to reduce the hedge to accomodate the withdrawal?

If they do nothing, they would be overhedged.

I believe C - over-hedge

Lets say you take a derivative position for 3 months to hedge your position. You now know you no longer need the hedge, which seem to be the case here.

An invested fund is an asset ie you are long. So to hedge you short. To reverse the short position, you over-hedge ie (cover the short + go long)

I am looking for corrections

thank you for the answer - I think the rationale is you don’t need to incur any more cost on the portfolio

where does this question come from?

example 8 in CFAI Reading 21 page 446

Here’s what I think it is. There’s two parts of you could choose to hedge for a foreign asset. The foreign asset it self and the currency exchange. The question is asking what you should do with the currency hedge. Which you shouldn’t do anything because currency is hedged which minimizes the currency risk and with the sudden need of liquidity its good that the agreed upon exchange is locked.

I think this is a trick question as it states in the curriculum that if a manager foresees immediate liquidity needs, it is better to go for a full hedge Since the question states that the fund Is fully hedged, the manager just needs to chill and do nothing However, had the question mentioned that the fund is partially hedged, the answer would be to overhedge.

My 2 cents

Did you get this answer?
Also congratulations on the charter.