Long or short on currency forwards confuses me.

CFA Level III
#1

So if we are worried about yen depreciation,beign a US nvestor holding yen, we should enter into a contract to sell the yen at a fixed price…

That is being short the yen forward right? We need to short a forward yen currency contract?

That make the most logical sense, am I right?

#2

Yes, if an US investor is holding Yen, then he should short Yen currency forward to hedge.

#3

if you own an asset - you sell a forward contract.

As a US Investor holding a Yen denominated assets - you have Bought the Yen Asset.

So you Sell a Forward on the Yen.

#4

Ok good, it is as simple as it sounds…

it confuses me because you short the contract, but you are long the currency…

Thanks fellas. We are going to kill this thing.

#5

So you sell a forward on Yen.

Specifically Yen/USD or USD/Yen? I always take the long way. Thinking you will benefit (in the forward/futures) when Yen depreciates. Therefore you want the contracted rate of 100 Yen/USD to drop to 102 Yen/USD.

The sell party payoff = (contracted rate - spot rate) X NP

However when you put this in the formula, you will realize something is wrong (negative payoff despite in your favor). The exchange rate should have been inverted. Is there a rule of thumb to connect the statement “sell a forward on Yen” to assume the denominator is Yen (USD/Yen). Then it is intuitively correct and you can connect the payoff (sell party) formula.

Any thoughts?

#6

look at the Denomination of the asset you own.

then you know what should be on the denominator when you calculate stuff.

otherwise you’ll get Yen^2/USD or USD^2/Yen … which would be weird.

But if u had Yen denominated asset - and USD/Yen on the currency - you get USD ,

#7

In this case the asset is denom in Yen. So I should focus the currency as USD/Yen, Yen being the denominator.

I hedge the currency risk by selling Yen forward, hoping to benefit when 0.01USD/Yen (assume contracted rate) depreciates to 0.009USD/Yen (assume spot at time T).

Then the payoff formula make sense.

Payoff (sell party) = contracted rate - spot rate) X NP = (0.01 - 0.009) USD/Yen * NP (Yen)

You got back the USD. clean and sleek!

Thanks cpk.

#8

where did oyu get the formula from?

#9

It’s a typical forward contract payoff depending if you’re buying (s - x) or selling (x - s).