UGG is an U.S firm who is exposed to the Japanese market by owning Japanese equity portfolio. Which of the following statements is most correct? (1) UGG can use yield beta to adjust their exposure to equities (2) UGG can fully hedge their foreign currency payment risk by selling the foreign currency forward (3) UGG can replicate a long stock position by buying equity futures and a risk free bond I do not get why (2) is incorrect! by selling japanese currency forward, UGG provide Japanese currency to the counterparty at a fixed rate to receive US $, thus effectively hedged the payment risk! Answer is (3) obviously
singlesong80 Wrote: ------------------------------------------------------- > UGG is an U.S firm who is exposed to the Japanese > market by owning Japanese equity portfolio. Which > of the following statements is most correct? > > (1) UGG can use yield beta to adjust their > exposure to equities > (2) UGG can fully hedge their foreign currency > payment risk by selling the foreign currency > forward > (3) UGG can replicate a long stock position by > buying equity futures and a risk free bond > > I do not get why (2) is incorrect! > by selling japanese currency forward, UGG provide > Japanese currency to the counterparty at a fixed > rate to receive US $, thus effectively hedged the > payment risk! > > Answer is (3) obviously (2) is incorrect because you can never do a perfect hedge because it is impossible to know exactly how much return the Japanese equity will offer. In other words, you can fully hedge the principle, but not the return componnent.
If they are equities you can’t even fully hedge the principal, because you do not know how much you will get back, if equity prices fall. It will then be either over /under hedge.
Agreed. But the answer said (2) is incorrect because UGG should buy instead of sell the foreign currency contract. I do not think buy is even remotely correct.