Q 1 about bid and ask rates- answer states that-
Given that that the size of the currency hedge is changing from USD 350 million to USD 400 million, Garcia is engaging in a mismatched hedge. Because USD is the base currency in the MXN/USD quote and the net amount of USD is being sold, the bid side of the spot rate is used in determining both the spot and all-in forward legs of the mismatched hedge.
my q is that when rolling over the contract, you have to buy fx to close forward and sell fx to initiate a new contract. Here, it’s combined into one. It should not matter what new is. We should be buying USD 350MM and selling 400MM forward at a ask rate for spot and bid for forward??? What amI missing here?
If the FX swap is mismatched then the pricing will need to reflect the difference in trade size between the two legs ie had the swap been matched we would have used the midmarket quote+ the bid of forward. since we are hedging more we need to sell more and therefore we will use the ask of spot rather than the mid market spot exchange + the ask in forward.
The answer uses the bid price for both spot and forward transaction. If we we are closing 350 hedge, we need to buy $350 at spot ASK and sell $400 at forward BID for the new amount, right?
If so, why does the answer state we use bid for both spot and forward transaction?
Thank you!
I would like some clarification too.
The CFAI text’s example for a mismatched hedge is in Blue Box “Executing a Hedge” in Section 6.1.1 for Reading 18. Their explanation ends with the statement “Hence, to pick up the net increase in forward EUR sales, the dealer that Yang is transacting with would price the swap so that Yang also has to use the bid side of the quote for the spot transaction used to settle the maturing forward contract.”
I’ve stopped trying to understand it and just accept it as a “guideline” - when engaging in a mismatched swap, if you are hedging the base currency, use the “side” (bid or ask) that goes with the NET Action you are taking - in our case, net selling of USD - use the bid for both spot and forward legs. The Dealer is “net buying” so it’s the bid side.
Hi,
The answer is simple. In the CFAI example, the investor has to sell JPY forward against HKD. In the quotation presented, the base currency is… the HKD not the JPY (that is JPY/HKD), so either you invert the quotation to get the JPY as your base currency or you take the opposite leg on the JPY/HKD (that’s using the ASK to sell JPY against HKD).
I hope this answered your question.