hedge or not hedge believes, indicate, interest, investor, relative

Dapper425

A French investor holds a UK bond. He believes that Euro will depreciate less relative to UK Pound than what the forward rate between the two currencies would indicate assuming interest rate parity.

Should he hedge the exposure to UK Pound?

Windjammer

He should not hedge because he expects the pound to be stronger than the forward market predicts

Unforseen

Not hedge. He will lose if he hedges.

skycfa

I'm having trouble without #s being presented.

Assuming 1.5 EUR/GBP

Euro rate = 5%
UK Rate = 1%

1.5594 EUR/GBP is what IRP says.

However, he believes EUR will depreciate less, so let's say 1.52 EUR/GBP is his projection.

When he converts the GBP to EUR, he can either get 1.5594 EUR per GBP or 1.52 EUR per GBP.

I'm saying he should hedge, is my logic somehow off?

NO EXCUSES

aidebaobao

So:

Euro: less depreciation than market = GBP: less appreciation than market, can we assume that? If so, then he should hedge and lock in the "expensive" GBP.

NO EXCUSES

bkballa

actually this is trickier than i thought. i misread at first. the foreign currency (the pound) is actually appreciating. but the investor believes that it will appreciate less than the market says it will.

so i think he should hedge. he should go long pound in the forward market.

is that right?

wake2000

this is the assumption i made. therefore, since he predicts the pound to perform worse, the pound is selling "expensive" in the forward market and he should go short pound.

i am using the logic on page 94-95 of schweser book 3, but this is a slightly different example since in the text the question involves a depreciating foreign currency.

would be curious from deriv what the answer is.



Edited 1 time(s). Last edit at Thursday, May 26, 2011 at 01:09AM by the show NY.

PalacioHill

.



Edited 1 time(s). Last edit at Thursday, May 26, 2011 at 01:10AM by the show NY.

bpdulog

I don't have the answer since I made it from example 19 on V4, P137.

I think bp is right. Here is my thinking:

"Euro will depreciate less relative to UK Pound than what is implied by forward market".

is equivalent to

"UK Pound will appreciate less relative to Euro than what is implied by forward market."

So, he will be better off if hedging UK pound.



Edited 1 time(s). Last edit at Thursday, May 26, 2011 at 01:11AM by deriv108.

thommo77

general (but related) question: is it still called heding if you go long? if forward rates said the pound was expected to appreciate 5% but you believed it would appreciate 3%, and you went long pound at 3%, is this a "hedge"?

or are you speculating?