proxy hedge. a cross hedge would be selling any Thai security against your Thai manufacturer purchase.
proxy. a cross hedge is not what newmaker said. the definition of a cross hedge is using two currencies other than the currency you are hedging for to minimize (eliminate) the currency risk of the third currency.
The only time both terms will be used is in currency forward or futures hedging. CAD co. wants to hedge japanese exposure. Problem: No CAD/JPY contract: Solution: Either proxy or Cross hedge. Proxy= Using other currency that is highly correlated with the JPY… eg say that you use Korean Won or something like that (if it is heavily correlated), so you use say a CAD/Kor. Contract. Cross hedging is using 2 contracts to hedge. EG using CAD/USD and USD/JPY, selling one and buying the other. In cross hedging in commodities or financial Forward or futures contracts you will use a like device to hedge. EG treasury forward for hedging a bank bond or Oil to hedge Gasoline if your a Gas wholesaler.
I thought proxy too, but Schweser says cross. I think it’s another BS solution. My rule is: if the foreign currency is correlated with the domestic currency -> cross if foreign currency correlated with initial foreign currency -> proxy
If my memory serves correct, it is cross hedge. If you invest in Thai and believe that koren currency is going to appreciate against USD, you may want to hedge Thai against Korean currency and gain when the korean currency appreciates against USD. If you have problem finding thai currency forwards but thai and korean are moving closely, you would want to sell korean currency forward instead of thai. this is proxy hedging. the way I rember is as follows: Let us say currency USD(A) base currency, you are investing in currency B, the third currency is C. Whenever the forward contract is used between B&C, it is cross hedge and whenever it is used between C&A, it is proxy hedge!!!
If I recall: Proxy Hedge --> if Country A’s currency is highly correlated with Country B’s currency then we can use Country B’s currency as a “proxy” to hedge Country A’s currency risk, say if Country B has high liquidity but Country A doesnt Cross Hege —> Country A is highly correlated with Country B’s currency and Country B’s currency is Highly correlated with Country C which has really cheap derivatives. So you might hedge Currency B’s currency with Country C… It’s all weird I know.
Cross hedge. A cross hedge is used to take advantage of differential currency movements. The purpose of the hedge in this case is to access the fact that Won will appreciate faster than Bhat and therefore you want to transfer the returns from Bhat to Won so that your total return includes the extra appreciation. It’s not a regular hedge, because the domestic currency is dollars. A Proxy hedge would be used if you cannot get a hedge directly from Bhat to Dollars, or such a hedge is inefficient because of liquidity or other transaction costs. If the argument was that the Won’s exchange rate fluctuates more or less in sync with the Bhat, the more liquid Won future would be a proxy that substitutes for the fact that you can’t get an attractive Bhat future. It’s probably easier to remember the proxy hedge and that cross hedging would be pretty much anything else that doesn’t involve the two primary currencies in the problem.
bchadwick Wrote: ------------------------------------------------------- > Cross hedge. A cross hedge is used to take > advantage of differential currency movements. The > purpose of the hedge in this case is to access the > fact that Won will appreciate faster than Bhat and > therefore you want to transfer the returns from > Bhat to Won so that your total return includes the > extra appreciation. It’s not a regular hedge, > because the domestic currency is dollars. > > A Proxy hedge would be used if you cannot get a > Thanks, great post. I got your point.
From my reading of the material, proxy ====> used really more for trading purpose. Currency A contract is hard to trade, and too illiquid, let me use currency B, since currency B is highly correlated with currency A and Currency B is a liquid contract. Corss====> used when the investor want to shift/change currency exposure due to expected curency movement. just my 2 cent.
the concept is best illustrated thru an exmaple proxy is if DC is dollars and you invest in japanese stocks and you hege ur yen exposure w/ the korean currency. Cross is u hedge ur yen exposure using CANADIAN DOLLARS and KOREAN CURRENCY
The point is you still want to protect your investment in your domestic currency. A proxy is when you short a different currency that is correlated to the currency you are exposed to; you do this against your home currency. In a cross hedge, you take the local currency you are exposed to and hedge it against some third currency. This is done because the manager feels he can benefit from exchange rates under these circumstances. Once the hedge expires and is completed, then you take your foreign currency proceeds and convert back to your domestic (home) currency.
Thank you very much Mo34 Your rule is useful yet simple. Great job!! mo34 Wrote: ------------------------------------------------------- > I thought proxy too, but Schweser says cross. I > think it’s another BS solution. > > My rule is: if the foreign currency is correlated > with the domestic currency -> cross > if foreign currency correlated > with initial foreign currency -> proxy
Its a Cross Hedge. right? Proxy hedge would be using a Won/USD contract and not a Bhat/Won then a Won/USD which would be cross… I think.
ws Wrote: ------------------------------------------------------- > From my reading of the material, > > proxy ====> used really more for trading purpose. > Currency A contract is hard to trade, and too > illiquid, let me use currency B, since currency B > is highly correlated with currency A and Currency > B is a liquid contract. > > Corss====> used when the investor want to > shift/change currency exposure due to expected > curency movement. > > just my 2 cent. I too have found the above useful in comparing the two. Any time they are transferring their risk exposure by using a 2nd and 3rd currency, it’s a cross hedge.
bigwilly Wrote: ------------------------------------------------------- > Its a Cross Hedge. right? Proxy hedge would be > using a Won/USD contract and not a Bhat/Won then a > Won/USD which would be cross… I think. the question doesn’t say that he used two contracts. They said cross based on the fact that he’s trying to take advantage of currency movements to increase his profit.
Yeah but he would have to use 2 to get the funds from the Won to USD, unless he did a spot transaction.
I don’t think you need two contracts for either type of hedge. I have not read that anywhere, so I’m always assuming that the other transaction is spot. ( I believe, that’s why they say in cross hedge, the third currency has to be correlated to the domestic currency, assuming you transfer back in the spot market)
I think it is a cross hedge. proxy hedge: hedge dome with 2nd foreign becoz 1st foreign has liquidity issue etc cross hedge: hedge 1st foreign with 2nd foreign
My take, cross hedge.
This is my understanding and it works: 1) Proxy hedge - enter into a forward contract betw domestic currency vs a 2nd foreign currency (which is correlated with the 1st foreign currency in which the bond is denominated) 2) Cross hedge - enter into a forward contract betw 1st foreign currency vs a 3rd foreign currency (not correlated BUT assume diff risk exposure) NOw assume we cant trade in THB (1st FC) and use a proxy VND (2nd FC) (positive correlated). 1) Using proxy hedge will be enter into a forward contract betw USD vs VND (VND is used as a proxy for THB) 2) Using cross hedge will be enter into a forward contract bew THB and WON (3rd FC) (not correlated since WON will appreciate more than the USD)