I would like to repost the already asked question because I have the same:
Reading 17. Currency Management: An Introduction. Question 22.
I am not really understanding this question. It sounds like the Swedish fund had some EUR exposure and decided to hedge this exposure by selling EUR forward contracts. Based on the data in the question, the monetary tightening by the Swedish bank has swung the forward points of the SEK/EUR rate to a premium (i.e FP>St, so the curve is now in contango). The question asks “Given the recent movement in the forward premium for the SEK/EUR rate, Bjork can expect that the hedge will experience higher:” the answer was B Roll Yield. How can this work? the question stated that their EUR exposure was already hedged by going short EUR forwards. How can a hedge that has already been implemented experience higher roll yield by having the curve switch from backwardation to contango? My thought process was that they hedged their EUR exposure by going short a forward and locking in a certain rate (eg. 1.2 SEK/EUR). The decision by the bank has put the SEK/EUR rate into forward premium (eg. 1.3 SEK/EUR), so the value of their forward contracts has fallen because they could have locked in a higher rate had they waited.
I agree, don’t get this one. I would think the lady would run a loss indeed with a hedged position (ie Short Forward contract SEK/EUR (which is increasing in value))… can anyone provide clarity? @S2000magician ? Please!
SEK rates increased - their curr should depr vs EUR or the foreign currency EUR should appreciate, which is what is expected to happen - it is given - EUR is now at fwd premium. If FC is at fwd premium and as time passes and nothing further happens to interest rates, the fwd premium will move back down to the spot rate (decline) and if you are a short position on that asset (FC) you stand to gain as you roll over. Hope that clarifies!
Thanks Geffo. Maybe it’s my misunderstanding in this case, as I understand the positive roll yield (when a FC sold at premium is rolling down). However in this example it looks like the Swedish Fund (managed by Bjork) was already hedged (that is what is in the example text) and that she locked in a price for selling the EUR currency forward at a premium. If you have a FC sold at a premium, and the FC points increase - this would mean that at the expiry date of the FC - (and if the higher FC price is still valid - as EUR would increase as mentioned above) - the Swedish Fund would have to buy back the EUR (to close the FC position) at a higher rate (and make a loss on this position!)
Or maybe I should not assume that the position was already hedge with a FC contract at a lower premium? but that she will be initiating buying a FC at a premium - which automatically means that she will have a positive roll yield.
- As we move forward in time, your shorter forward contract will need to roll over to continue the short exposure. But since underlying factors don’t change, the higher forward price will move down and converge to the more realistic spot price.
- The leg of the fwd contract which was entered into at a fwd premium will unwind at a gain (+ roll from short posn at a higher price and delivering at lower spot)
- Remember this is continuous hedging to maintain long term exposure from short duration fwd contracts - called FX swaps
“ the Swedish Fund would have to buy back the EUR (to close the FC position) at a higher rate (and make a loss on this position!)” this part is incorrect- you will have to deliver the EUR which you will get at the lower spot price and hence gain on the short position since you had shorted it at a higher fwd price so the opposite party in the fwd will have to collect it at that higher price”