Currency hedging question

CFA Level III
#1

Hi everyone,

Would appreciate some clarification here please

Economics book, P349 Question 2…

It says the absolute cost of the hedge is 2.5% and the expected depreciation of the foreign currency is 2.2%, it recommends not to hedge because we would be locking in the higher deprecation of 2.5%

However, can someone please explain… if we are long the foreign currency and need to sell it forward, then why wouldn’t we want to lock in the bigger deprecation with the hedge?

Seems like because its trading at a forward discount, we want to sell at the higher of the two numbers?

confusing. Thanks.

#2

If you lock the higher depreciation you will be locking a lower value.

e.g if the foreign value let say is 0.80 and you lock in the 2.5, then you will be getting .08 x (1-0.025) = 0.78

if you do not hedge then you will get 0.80 x (1 - 0.022) =0.7824

you wan the foreign currency to depreciate less, not more

#3

Thanks, appreciate it.