Need help here to fix this please. To determine if a domestic currency need to be hedged or not. What is the rule in basic word?
Using IRP, if Id - If > forecast ?
If Id -If is positif ?
When is the domestic currency says to depreciate / appreciate and what to conclude?
Hedge if you think it will help; don’t hedge if you think it will hurt.
You want more domestic currency. Hedge if you think you will get more domestic currency; don’t hedge if you think you will get less domestic currency.
Example 1: dr = 2.5%, fr = 1.5%, and you think that the domestic currency will depreciate 1.5%. What to do, what to do?
(For reference: domestic currency appreciating is bad; domestic currency depreciating is good.)
IRP says that the domestic currency will depreciate by 1.015/1.025 − 1 = 0.9756%. You think it will be better: depreciating by 1.5%. Don’t hedge.
Example 2: dr = 1.5%, fr = 2.5%, and you think that the domestic currency will appreciate 1.5%. What to do, what to do?
IRP says that the domestic currency will appreciate by 1.025/1.015 − 1 = 0.9852%. You think it will be worse: appreciating by 1.5%. Hedge.
S2000 - thanks a lot for this effort .
Do we always need to consider or think domestic currency depriciating?
Can u plz explain this by assuming that “analyst expecting that foreign currency will appreciate/depriciate”
shall we just reverse the equation and derive relation
Who needs Schweser when you’ve got S2000magician? Thank you so much for that. You make it look so easy (wish it were).
S2000Magician, I always dreamed of that day you will come down to one of my post and shed your so bright light. How can one single human being be so smart!!!
I just made a flascard of this. I understand it so easily now
Sure. It works either way.
(For reference: foreign currency appreciating is good; foreign currency depreciating is bad.)
Example 1: fr = 2.5%, dr = 1.5%, and you think that the foreign currency will depreciate 1.5%. What to do, what to do?
IRP says that the foreign currency will depreciate by 1.015/1.025 − 1 = 0.9756%. You think it will be worse: depreciating by 1.5%. Hedge.
Example 2: fr = 1.5%, dr = 2.5%, and you think that the foreign currency will appreciate 1.5%. What to do, what to do?
IRP says that the foreign currency will appreciate by 1.025/1.015 − 1 = 0.9852%. You think it will be better: appreciating by 1.5%. Don’t hedge.
I married the right woman.
can someoen confirm my thought process - feel like I have a brain fart.
I buy foreign bonds. lets say foreign fx projected to depreciate 1% (ie dom to appreciate 1%)
if the foreign RF is 5%
if the dom RF is 2.5%
ie by hedging, I can sell the foreign RF forward (and pay -5% + 2.5%) and lock in a loss of -2.5%;
comparing this to fx loss of 1%,
I should NOT hedge.
Whether you hedge or not depends only on your expectations of the currency exchange rate vs. interest rate parity. The return (in foreign currency) of the investment is irrelevant.
If you think that the domestic currency is going to depreciate more (appreciate less) than IRP suggests, _ don’t _ hedge.
If you think that the domestic currency is going to appreciate more (depreciate less) than IRP suggests, don’t hedge.
Ignore the return on the investment when making the hedging decision; concentrate on the FX return.
so my thought process on using the Rf rates to approximate IRP was correct in the above example?
The decision to hedge or not to hedge depends on:
Nothing in your thought process indicated your expected appreciation/depreciation. Without that, the decision cannot be made.
Maybe it’s just been a long day of studying lol but here it is
we expect foreign fx to depreciate 1%
via the Rf calc above we expect the fx to depriciate by 2.5%
therefore, more upside (since Dom is now expected to appreciate by 2.5) to NOT hedge
is that better?
Correct.
S2000, according to the above statements, I had gathered that if I think DC will depreciate more than IRP suggests, I want to take advantage and leave that UNHEDGED, and when I expect it will appreciate more than IRP suggests, I should HEDGE. For your last comment, that relationship seems to be reversed. Can you clarify?
The last comment was wrong; I probably made it after a long, tiring day.
Thanks for catching it. I’ve corrected it.