currency hedging: the basics

This is definitely my weakest topic. Does anyone care to provide some basic concepts around currency hedging when we expect currencies to depreciate/appreciate: options vs. forwards, puts vs. calls, buying vs. selling contracts? For example: if we are RECEIVING a FC (foreign currency) in the future, and think that the FC will DEPRECIATE, we should BUY an CALL option. (could we also use put options somehow?) In the same situation, we could also enter into a FORWARD contract to lock-in the exchange rate (which is less flexible than using options, and the forward may result in a gain or loss on the contract). Is this correct? Any input from AF is greatly appreciated!

if you are receiving foreign currency you are long, so should short futures or buy puts if you are paying foreign currency you are short, so should go long futures to hedge or buy calls

KR, so we can we also hedge interest rate risk of bond portfolio by buying options on bonds rather than interest rate options ? eg. hedging bonds on asset side for changes in interest rate when considering the pension liability which acts as a bond ?

If you are receiging foreign currency in the future, and you expect the FC to depreciate, you would sell that FC forward, i.e. sell currency futures or forwards, to lock in the higher price now. But, only if you expect it to depreciate more than is currently baked into the currency rate.

Zombie71 Wrote: ------------------------------------------------------- > This is definitely my weakest topic. > > Does anyone care to provide some basic concepts > around currency hedging when we expect currencies > to depreciate/appreciate: options vs. forwards, > puts vs. calls, buying vs. selling contracts? > > For example: if we are RECEIVING a FC (foreign > currency) in the future, and think that the FC > will DEPRECIATE, we should BUY an CALL option. > (could we also use put options somehow?) Imagine that you have “invested” in a cash flow from a foreign currency. You are in effect long the foreign currencies as soon as you contract to receive it. Since you are long the FC, if you don’t want to subject yourself to currency risk you would sell it forward (as with any asset if you don’t want the risk sell it or in this case hedge it). Should you not hedge it would help if the currency appreciated (think of it like a stock…you want it to go up). If you think it is going to depreciate then you should hedge. Symmetric hedging will lead you to a future/forward. Asymmetric hedging would put a put on the foreign currency. > > In the same situation, we could also enter into a > FORWARD contract to lock-in the exchange rate > (which is less flexible than using options, and > the forward may result in a gain or loss on the > contract). Is this correct? Yes, but, if you hedge is effective the gain/loss in the forward will be offset by the gain/loss in the currency itself and it is a wash (long the currency - short the forward).

Thanks Mwvt9 and others. That was very helpful, and all things I actually know, but after a long day I was struggling with this for some reason.

Zombie, i hear ya…this is also my weakest topic…i know all this stuff but somehow i’m still getting stumped.