Help me out with Easy Schweser question

Probably just too lazy to look this up, but I don’t understand this Schweser answer: If a manager plans to use currency forwards to hedge a long position in foreign equities, then which of the following would be a reasonable strategy? A) Short an amount that is more than the current equity position. B) Go long an amount that is more than the current equity position. C) Short an amount that is less than the current equity position. Your answer: A was incorrect. The correct answer was C) Short an amount that is less than the current equity position. The manager would want to short the forward contracts to hedge depreciation of the foreign currency. The manager would want to hedge an amount less than the equity position because that position may decline in value from the equity risk.

This doesn’t make sense. I mean what they say is true, but if you are long the foreign equity you have to believe it has a positive expected return in which case the answer would be A. It’s like they left out additional information.

^exactly what I was thinking. I would have picked A as well.

That’s what I thought.

this is a bad question I mean if anything why would you go into a position when you think it has a better chance of going down in value. and if you think it will go up you should take a position at least equal to the initial amt.

doesn’t make sense.

Negative correlation (I think the curriculum said somewhere that negative correlation is generally the case) between FX returns and stock market returns means that some of the FX exposure is already effectively hedge by the stock position. You would need a beta (of FX regressed agaist stock return) to compute the # of contracts.

florinpop Wrote: ------------------------------------------------------- > this is a bad question > I mean if anything why would you go into a > position when you think it has a better chance of > going down in value. and if you think it will go > up you should take a position at least equal to > the initial amt. You don’t expect it to go down. You expect it to be negativelly correlated with FX. It ain’t rocket science (unless of course, the equity position is in rocket manufacturers)

I picked C. It’s equity, it’s not like it is guaranteed to gain in value.

olivier Wrote: ------------------------------------------------------- > Negative correlation (I think the curriculum said > somewhere that negative correlation is generally > the case) between FX returns and stock market > returns means that some of the FX exposure is > already effectively hedge by the stock position. > You would need a beta (of FX regressed agaist > stock return) to compute the # of contracts. I remember that emerging markets generally have a negative correlation with the local currency, but not all markets generally. OK. Everyone can stop wasting their time on this Schweser BS. It’s not me. It’s a lousy question.

olivier Wrote: ------------------------------------------------------- > Negative correlation (I think the curriculum said > somewhere that negative correlation is generally > the case) between FX returns and stock market > returns means that some of the FX exposure is > already effectively hedge by the stock position. > You would need a beta (of FX regressed agaist > stock return) to compute the # of contracts. This is the hedge ratio calculation and I agree with what you wrote, but absent additional information I think this is a pretty bad question. I bet this is one where they are trying to ask about one specific concept (like and LOS question), but outside of that context it doesn’t make sense, IMO.