forward contract and interest rate contract, receiving, interest, receive, currency

brain_wash_your

Hi all,

R40 Currency Risk Management

"When a Japanese investor hedges her U.S. assets against currency risk,
she sells dollars forward against yen and must pay the U.S. dollar interest rate
while receiving the yen interest rate."

Why must she pay the U.S. dollar interest rate and receive the yen interest rate??

This interest rate matter relates to basis risk?

Please explain about this interest rate..

infinitybenzo

CPK, are you sure of this explanation? Read the question again... The Japanese investor is hedging against currency risk of holding USD denominated assets. This contract means that the USD exposure has been converted to Yen exposure. Please read again...

Unforseen

For a Japanese client, underlying exposure is USD. In this case the Japanese investor want to be long a JPY forward contract (or future) to be immune to currrency movements. Equivalent to the same is client needs to sell USD and buy JPY.

Currency exchange is a function of two interest rates (USD and JPY). Since you are selling USD (you are paying USD interest rate), and since you are buying JPY (you are receiving JPY interest rate).

lcw77

manet_5 Wrote:
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> Thanks all !

Where are those statements quoted by you ?

skycfa

R40 P.316 "Costs" part

zwjy

manet_5 Wrote:
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> R40 P.316 "Costs" part

manet_5 : TKVM !

Analyze_This

BTON04 Wrote:
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> Since you are selling USD (you are paying USD interest rate), and since you
> are buying JPY (you are receiving JPY interest rate).

BTON04 :
Can you explain the logics ? Thanks !

jmh530

Why selling USD shall USD interest rate buying JPY shall pay JPY interest rate ?

Anyone can help ? Thanks !

wake2000

^
Lets say we are Selling USD to buy JPY.

For Selling USD, I must have USD first, so say I am borrowing it to Sell it. So, on USD (my sell currency) I PAY USD interest.

For Buying currency JPY, which I get from the contract, I can invest it and RECEIVE JPY interest rate.

Actually, this paying and receiving of interest rate physically happens ONLY if FX Forward rates are mispriced and I am cashing in on an arbitrage opportunity. In a regular FX Forward contract used to hedge risks, as in this case, paying and receiving of interests does not happen physically, but is implicit in the Forward Rate.

Hope it helps.