is to invest in futures and options because the only money you put down is the premium and margin?
if you hedge margin you will have 0 currency risk with futures
They may ask you this and the answer will be based upon: a) if you want a perfect hedge and/or cost is really an issue (then use futures). b) if you want “insurance” or downside protection and/or cost is not an issue (then use options, most likely a put on the currency in question).
This is not necessary the best way. It one of the many ways?
Furthermore, if a manager is trying to hedge the currency risk with maintaining the local currency return %, then futures are the way to go. However more likely it will be presented that a manager (who is probably more about getting some level of active return is pondering hedging), in this case the option may be the better idea if he feels there may be a downside threat and the potential for upside on the currency.
My understanding is that you use futures if you’re main concern is downward protection. If you’re main concern isn’t necessarily covering downward moves but you have no strong opinion one way or another, options is the way to go. Not sure the above makes sense but I do remember reading about it. Are there any rules of thumb we can use here in case its asked on the exam which hedging method is preferred?
PJ, both will protect on downside, but Options will allow you to participate in the upside where as futures won’t
the tradeoff is the premium you have to pay for the option vs. giving away your upside potential