Wow. Thing people might be making this more difficult than it is. Proxy - use another currency to hedge if cheaper, more liquid etc. Highly correlated with home currency. Cross - trading one exposure for another. Could just be because you think one will appreciate more relative to home currency.
jmac01 Wrote: ------------------------------------------------------- >Highly correlated with home > currency. No, the new foreign currency is highly correlated with the original foreign currency (i.e, your exposure), NOT with home currency (i.e., the domestic currency) No need to make things more confusing than needed, right :-).
nope. agree to disagree. what would be the point in entering the cross hedge?
oh. wrong one. but you are still wrong and the whole reason you enter the proxy is to get out of the original currency. you need the movements of the proxy country’s currency to move like your home currency.
jmac01. Check your book, my friend. Here I quote the definition from the CFAI text book. “Proxy hedging involves using a forward contract between the home currency and a currency that is highly correlated with the bond’s currency. The investor may use proxy hedging because forward markets in the bond’s currency are relatively undeveloped, or because it is otherwise cheaper to hedge using a proxy” Can’t be clearer than this ?
Two ways to do a proxy. 1. you can turn the foreign assets currency into a currency that is correlated to the home currency (using the 3rd currency as a proxy for home currency). 2. or you can enter an agreement to turn a currency that is correlated with the foreign asset into the home currency(using the 3rd currency as a proxy for the foreign asset). The bond’s currency isnt always the one that requires the use of a proxy. so, i am with you if going by number 2.
jmac01 Wrote: ------------------------------------------------------- > Two ways to do a proxy. 1. you can turn the > foreign assets currency into a currency that is > correlated to the home currency (using the 3rd > currency as a proxy for home currency). What you are describing is essentially doing a CROSS hedge (not proxy hedge): turn the foreign currency to ANOTHER currency (which may or may not correlate with the home currency. The fact that it does or does not correlate with the home currency is not relevant). In case you doubt it, here is the quote from CFAI “cross hedging refers to hedging using two currencies other than the home currency and is a technique used to convert the currency risk of the bond into a different exposure that has less risk for the investor” 2. or you > can enter an agreement to turn a currency that is > correlated with the foreign asset into the home > currency(using the 3rd currency as a proxy for the > foreign asset). > Yes, this is a proxy hedge. > The bond’s currency isnt always the one that > requires the use of a proxy. Not sure what you mean here. > so, i am with you if going by number 2.
the difference in a cross hedge and proxy is largely the intent of the hedge. Proxy is caused by the inability to obtain an effective contract that turns the foreign currency into your home security using forwards etc. i.e. using one currency as a proxy for another. Cross is trading one exposure for another. Or you can memorize a definition from a textbook glossary and try to act like you are the smartest person on a message board. just messing with you. not sure why we are still spending time on this…done.
I bet on the exam they will ask us to discuss the difference between a cross and proxy hedge. That would be hilarious.
Well, why need complicated? Suppose you have a bond GBP while your domestic currency is USD. You want to hedge the exchange rate between GBP and USD right. You can use 1/ Forward hedge : Enter a forward contract directly for USD and GBP 2/ Proxy hedge: If the forward contract is not directly available for USD and GBP than you can enter a forward contract between USD and a third currency such as EUR (assume that EUR is highly correlated with GBP) 3/ Cross hedge: You expect that EUR will appreciate in the coming time when there is expectation about a decreasing value for GBP. Now you enter a contract to exchange GBP for EUR. In this case, you exchange exposure from GBP to EUR but still, you expose to currency risk with EUR. You just switch currency exchange risk exposure from GBP to EUR. After all, the processes to hedge in proxy and cross hedge are very similar but we do this with different purposes. Hope it help.