infinitybenzo

<< ilvino said :
At t=1, they will need to exit this position, requiring them to sell Pounds and buy back their original currency. >>

The FX dealer will not let you have that risk-free profit. It will immediately adjust its forward currency rate to remove that arbitrage opportunity.

infinitybenzo

Guys:

This concept is stated on the reading 40 CFAI page 316 on the bottom under "costs" and in level 2 last year.

When you hedge the currency risk (risk of FC decreasing), you sell the FC currency forward and therefore "pay" the FC interest rate (or borrowing at the FC rate) while earning the DC interest rate. In the example provided, the FC rate>DC rate, so a hedger will end up borrowing at GBP rate, which is higher than the USD rate. This is why the journal says it might not beneficial to hedge.