mcmc

This is what a currency trader in my firm tells me.

Forward exchange rates adjust immediately. So let us say, at t=0, there emerges a 1% differential between the UK rates and the US rates, the 1-year forward exchange rate will immediately drop by 1%. There is no lag.

Now if you are a US investor who invested in British assets at t=0, then selling the pound one year forward will eliminate the interest rate differential, the spread you wanted to make in the first place. However, if you believe that the pound (fwd rate) has no further downside and no way to go but up, then you should not buy the forward hedge. The opposite applies to the British investor.

It makes sense to me.

MG.