2011 sample question - currency risk

Munoz says that he has read a number o things about currency risk that he isn’t sure about, including:

Statement 1 - Currency risk is difficult to eliminate

Statement 2 - Currency risk should be netted across all portfolios

Statement 3 - Currency risk tends to be smaller over longer horizons

Question - Of the 3 statements Munoz makes about currency risk, which one shoud be least likey to agree with:

A -statement 1

B- statement 2

C- statement 3

What do you think?

Statement 1 is true because you cannot know for sure the hedged position size, or the pair is illiquid.

Statement 3 is true because currency’s tend to move towards their fair value (REER), so movements over long periods are somewhat predictable

Statement 2 is not so true because of statements 1 and 3, if by netted, they mean the standard deviation of the currency risk in the portfolio, then you have a problem with relative weights, and the SD itself. This is probably the answer because I’m not as sure about it, lol.

Munoz says that he has read a number o things about currency risk that he isn’t sure about, including:

Statement 1 - Currency risk is difficult to eliminate: TRUE: if your are really concerned about currency risk, you can always hedge it with futures or forward contracts or even by gaining exposure to multiple foreign currencies. However unhedged returns might end up enhancing your return.

Statement 2 - Currency risk should be netted across all portfolios: FALSE: Can’t be netted you should get exposed to some currency risk exposure even if you are hedged or the currencies on your portfolio is low correlated.

Statement 3 - Currency risk tends to be smaller over longer horizons: TRUE: if you have a long-term time horizon, exchange rates are likely to revert to their “natural” levels in the long-run

The answer is statement #3 though…

Why do you think that is?