Forwards/Futures, Exchange Rate Risk currency, successful, contract, only, lock

Carson

Reviewing the obscure stuff, from my notes.. for the exchange rate risk of a foreign market portfolio.

There are 2 strategies to "lock in" the future portfolio value, with exchange rate futures:

(1) you hedge the equity market risk only... where (if successful) you should earn the foreign Rf rate on the notional amt hedged
(2) you hedge the equity mkt AND the currency risk... where the notional amt of the X/R contract is the amount earned if invested in foreign Rf rate. If successful, return should be domestic Rf rate.

Can someone explain why (1) and (2) are so? It's not going in, for some reason.

canadiananalyst

Thats what she said.

justin88

Neveruse_95%_everagain Wrote:
-------------------------------------------------------
> Reviewing the obscure stuff, from my notes.. for
> the exchange rate risk of a foreign market
> portfolio.
>
> There are 2 strategies to "lock in" the future
> portfolio value, with exchange rate futures:
>
> (1) you hedge the equity market risk only...
> where (if successful) you should earn the foreign
> Rf rate on the notional amt hedged
> (2) you hedge the equity mkt AND the currency
> risk... where the notional amt of the X/R contract
> is the amount earned if invested in foreign Rf
> rate. If successful, return should be domestic Rf
> rate.
>
> Can someone explain why (1) and (2) are so? It's
> not going in, for some reason.

1) is all about the Stocks = Futures + Risk Free Rate relationship.

If you hold stocks, and you hedge that with futures, you have Stocks - Futures = RF.

Therefore, you're earning "only" the foreign risk free rate.

2) If you then hedge that foreign RF rate away with currency futures derived from IRP, your "remainder" is your domestic RF rate (I'm not gonna, nor could I, derive this for you - just take my word for it).

1morelevel - that made me literally laugh out loud.

lcw77

I do what I can

liangfeng

thanks both. I figured someone would take the bait : )