Domestic Currency (DC), Foreign Currency 1 (FC1), and Foreign Currency 2 (FC2) The forward rates are in agreement with the interest rate differentials and indicate: FC1 will depreciate 1.3% and FC2 will depreciate 1.5%. Lets say we expect FC1 to depreciate only 0.5% and FC2 to depreciate only 1.1%. Why should we hedge FC2 into FC1?
1.3-.5 = .8 1.5-1.1 = .4 More money can be made in FC1 based on the manager’s expectations.
Where is this question from. I remember seeing a dual currency question that I wanted to look at come the week before. Thanks…
I should probably say the manager would lose less money
So bpdulog, trying to decipher what you said: Since the differential between Forward Rate and Expectation is 80 bps in FC1 vs only 40 bps in FC2, the aim here is to do a Cross Hedge by taking an active position on a Forward between FC1 and FC2. This strategy will make money to partially offset the currency loss on the original investment in FC2.
If you look at it from any angle, FC1 will depreciate less than FC2 which is good.