Hi, I still have hard time with the "whether to hedge or not " decision for the fx. Could somebody explain it -in case of manager’s expection is more or less than the forward ?
If you hedge, you lose any appreciation in the fwd ccy. But, you protect yourself against any depreciation. The appreciation or depriciation is to be determined with respect to the fwd rate(implied by the IR differntial). If expected rate > forward, you stand to gain by not hedging, because hedging gives you the forward rate and not-hedging gives you the expected rate. The exact reverse holds true when expected < forward.
If the expected spot rate in 1 year is say 0.80 USD/EURO, but the Forward Rate given the Interest Rate differential between say the US and France is 0.85 USD/EURO, which one is better? Well Let’s play with fake money. If I was a US investor and I had 1,000 Euros which rate will give me more money. If I use a Forward contract I’ll get $850, whereas if I don’t use a forward I’m only expected to get $800. So I want to Hedge the 0.85 FX rate to lock in the better FX rate.
Thanks guys- you saved me a lot of headache.