Currency overlay not understanding at all

CFA Level III
#1

“Dias has asked whether it would be appropriate for him to hedge his foreign currency exposure. Campos raises the issue with Traldi and Peixaria. Traldi responds, “In the short run, if the correlation between foreign asset returns and foreign currency returns is negative, then there may be a need to hedge all foreign currency exposure. Alternatively, one could implement a currency overlay program in which the currency exposure is fully hedged and currency alpha is generated separately. This currency overlay strategy will only be successful in adding value to the portfolio if the currency alpha has a high correlation with Brazilian equities and corporate bonds.””

Q is " In her response regarding hedging foreign currency exposure in Dias’s portfolio, Traldi is most likely:

  1. incorrect about the correlations, but correct about the currency overlay program.
  2. incorrect about the correlations and the currency overlay program.
  3. correct about the correlations and the currency overlay program"

Answer
B is correct. Traldi is incorrect about the correlations and the currency overlay program. In the short run, if the correlation between foreign currency asset returns and foreign currency returns is negative, then there may be no need to hedge all foreign currency exposure because some currency exposure is desirable from a portfolio diversification perspective. Regarding the currency overlay program, it will add value to the portfolio only if the currency alpha has a low correlation with other asset classes in the portfolio (i.e., Brazilian equities and corporate bonds).

A is incorrect. Traldi is incorrect with regard to correlations and the currency overlay program.

C is incorrect. Traldi is incorrect with regard to correlations and the currency overlay program

I don’t understand this. 1. If correlation between foreign currency asset and foreign currency is negative wouldn’t you want to hedge b/c some currency exposure is desirable? 2. Same goes for overlay, if there is low correlation why bother hedging? Don’t get this.

#2

If the correlation between foreign asset return and foreign currency return is negative it means that when the foreign asset increases in price (we suppose the investor is long the foreign asset) the foreign currency depreciates (if the investor is long the foreign asset then he is long the foreign currency) and the investor doesn’t need to hedge the currency exposure because the hedge is supposed to protect against the foreign currency depreciation.

If the alpha generated by the currency overlay program is correlated with the foreign assets the fund invested in then… the fund doesn’t need an overlay program which costs money to implement or said otherwise maybe the overlay program will just generate return from a mere beta currency exposure like the fund could do by just being invested in the foreign assets.