Afternoon exam, question 24 on hedging currency exposure:
- U.S. based firm acquiring a firm in the U.K. with GBP 400mm in holdings
- U.S. vol = 4.6% // GBP Vol = 2.5%
- Corr = 0.25
Question from practice exam: ‘Using the information in Exhibit 1, which position would best implement Bluerock’s min-var hedge against Concord Associates’ exposure?’
Formula: hedge = corr * (vol DC / vol FC)
=0.25 * (4.6% / 2.5%) = 0.46
Notional of GBP 400mm so we get:
Hedge position = 0.46 * GBP 400mm = GBP 184 million
Answer options:
A - short a GBP / USD forward contract with a notional size of GBP 184mm
B - long a USD / GBP forward contract with a notional size of USD 184mm
C - long a GBP / USD forward contract with a notional size of GBP 184mm
Answer explanation in answer key (after giving you hedge amount):
"Bluerock will have a holding of GBP 400 million after the acquisition. Bluerock should short the GBP in a forward contract to hedge the risk of exchange rate fluctuations.
Hence, Bluerock should be long GBP / USD."
I’m going crazy here! The second to last sentence seems to imply answer A, while the very last sentence (and the correct one, per the answer key) implies answer C. What am I missing? Is this just an error? That second to last sentence is repeated almost word for word in answer A!
Thanks if you can set me straight!
