Cross Hedge vs Proxy Hedge

CFA Level III
#1

I cannot figure out the explanation in the textbook.

Can someone explain the difference between the Cross Hedge & Proxy Hedge and when you would use either in a portfolio in the context of currency forwards?

Thanks

#2

cross hedge

you need JPY to USD.

JPY/EUR -> EUR/USD for getting from JPY to USD -> these are currencies that are profitable to trade.

Proxy Hedge -> you want to go JPY/USD, - You are unable to find a dealer giving you a good deal on EUR, but know EUR and CHF are highly correlated. So you go JPY/CHF and from CFH/USD.

CHF is used as a proxy for the EUR.

That is my understanding. Please correct if I am wrong !!!

#3

My understanding of the cross hedge is the same as CPK’s, but that of the proxy hedge differs.

Proxy Hedge:

you want to hedge USD but can’t find a JPY/USD quote (I don’t know maybe you went blind…) you know the HKD closely mimics the USD so you hedge the HKD instead. At the end of the hedge the hope is that the HKD hedge performed closely to what a USD hedge would have if you could have entered into that hedge.

#4

FinNinja is correct and cpk is incorrect. The names should be self explanatory. In a Cross Hedge, you cross through an intermediate currency trade, but ultimately hedge the currency where you hold risk. In a Proxy Hedge, you cannot trade the currency that you want. So, you use a correlated currency as a proxy.

#5

thanks for clearing that up. It has been some time … and I got confused.