In reading 37 (risk management), question 16 in the CFAI text, the question asks if it is correct/incorrect to hedge the currency and market risks given the following situation: - an oil service company whose income is closely linked to the price of oil - the company derives the majority of its income from sales to the US - the economy of the company’s home country depends on export oil sales to the US - movements in world oil prices in US$ and the US$ value of the home country’s currency are strongly positively correlated - a decline in oil prices would reduce the company’s sales in US$ terms - appreciation of the home country’s currency relative to the US$ would reduce the company’s sales in terms of the home currency The answer says that neither of the risks should be hedged. Why is this so? I thought that you would want to hedge both risks because: 1. hedge market risks to eliminate the negative effects of a possible decline in oil 2. hedge currency vs the US to eliminate the negative effects of a possible depreciation in US$
billwest Wrote: ------------------------------------------------------- > - movements in world oil prices in US$ and the US$ > value of the home country’s currency are strongly > positively correlated This is the key. Because of the oil price in US$ is positive correlated with home currency. This already provides a natual hedge for the oil producer.