2012 Sample Q34-When Currency should be hedged 2012, part, remember, currency, question

LiquidAssets10

I got this question wrong. and very confused.
I get the part that the market expects foreign currency to depreciate 0.75, well manager expects a 0.35% deprecitation.But it is always hard for me to remember whether a manager should hedge a overprice or an underpriced foreign currency?
Should we always hedge an overpriced one?

spartan1

I’m confused as well…haha.

profil

Is the answer not to hedge? You shouldn’t lock in a .75% depreciation if you only think it will depreciate .35%.

LPoulin133

Its very tricky…the firm is invested in pounds so an appreciation of the pound/depreciation of the euro is a GOOD thing.
the appreciation of pound via interest rate parity ~ 0.75% . the managers expect appreciation of 0.35% (or depreciation of 0.35% of the euro).   thus, you hedge to lock in the 0.75% gain (remember they’re invested in pounds and wanna gain from the pound)
i got it wrong the first time, too…tricky question

hinsafdar

the Euro is the domestic currency, so you are holding the foreign currency, the pound
would you want your foreign currency to appreciate or depreciate? you want it to appreciate, right?
so, if you forecast that the euro will depreciate by 0.35%, that means the GBP will appreciate by +0.35%
the forward markets are telling you that the euro will depreciate by 0.75%, meaning the GBP will appreciate by +0.75%
so you want to pick the one most beneficial to your foreign currency holding of the GBP, which is +0.75% in the forward markets = you would hedge and get the +0.75% return rather than only the +0.35% gain that you are forecasting if left unhedged