LOS 14.41.a: Risk Mgmt. I am stuck with currency hedges, maybe I do not 100% understand how these transactions work. The problem is hedging an investment in a foreign currency. Using Schweser notation: R_hedged = R_unhedged + R_Fut where R_(un)hedged refers to the return on the (un)hedged position (i.e. foreign currency exposure), and R_Fut is the return from the futures contract used to hedge the foreign currency. R_unhedged = (S_t * V_Lt - S_0 * V_L0) / (S_0 * V_L0) where S_t … spot price of currency (exchange rate) at time t S_0 … current (initial t=0) spot rate V_L0 … current value of investment in foreign currency V_Lt … value of investment at time t So far it is clear to me. However, the R_fut part troubles me: R_fut = - (F_t - F_0) / (F_0) where F_t is the futures exchange rate at time t, F_0 at time 0. I do not understand why F_t is used here. As I understood it, you buy protection (hedge) at time 0 for the duration of t. At t, the future expires (Is that correct?). So why is anyone interested in the futures excange rate, as i am not going to enter another of these contracts at time t? From my understanding the formula should read: R_fut = - (S_t - F_0) / (F_0) Can someone explain this to me? Somehow I think I totally got this concept wrong… Thanks in advance, oa.

Its not necessary that the future expire at T. They expire only on certain dates and generally speaking, your investment horizen and time to expiry of future will most probably not match. Assume a USD/INR future that starts on 1 Jan and expires on 30 June. You enter on 1 Feb and leave on 28 Feb. Because of Basis, Future price on Feb 1 wont (99% times) equal Spot price on Feb 1. Thus you entered at F_0 and left at F_t. The rest is plug and chug

I agree with Bhaiyyu.