CCY exposure to hedge or not?

[GET_RID]

Do you guyz have any easy way to remember the logic behind when to hedge and when not to hedge a foreign currency exposure an investor has?

Just to give a further light on my question - An investor has an exposure to a foreign CCY (say USD) against its domestic CCY(INR). The market expectation based on interest parity is that INR will depreciate by 10% however the manager/investor expects INR to depreciate by only 8%. So whether he would hedge or not hedge?

I know the answer for it but want to understand how to crack it…

[S2000magician]

If you hedge, you guarantee a 10% depreciation of INR (vs. USD).

If you don’t hedge, you expect only an 8% depreciation.

Which would you rather have?

[MrSmart]

It’s more of a weight scheme towards hedging the full position, and not hedging at all.

That depends on how much he believes each will happen.

[oz001]

@MrSmart

It’s more of a weight scheme towards hedging the full position, and not hedging at all.

That depends on how much he believes each will happen.

s2000Magician is correct.

Probability is not a consideration here because the investor’s expectation for USD appreciation (8%) is less than what the market expects (10%). The investor is long USD so it makes sense to hedge and lock in the 10% fx gain.

Your argument on probability weighting would hold if investor expected INR to depreciate/USD to gain by > 10% (market expectation)

[Gurifissu]

Depends on your initial position (long/short) versus your forex expectations. If you’re long X and expect it to depreciate, it might be advisable to hedge your position. However, you need to take into account the forward premium/discount at which the currency is traded, because when you’re hedging, you’re effectively using forward instruments. If the cost of hedging > expected benefit from hedging, you might consider not to hedge even if your position will suffer, but this could depend on your macro & micro expectations.

[S2000magician]

@oz001

@MrSmart

It’s more of a weight scheme towards hedging the full position, and not hedging at all.

That depends on how much he believes each will happen.

s2000Magician is correct.

It happens so rarely that it shocks some people.

[oz001]

@S2000magician

It happens so rarely that it shocks some people.

[crosstheevil]

I find it strange that in some exercises, managers bizarrely know the directions and the degree (%) that the currency will move (either up or down) like they have some sort of crystal ball. I always thought that you have to hedge the unknown - you can’t be too sure, that’s the purpose of hedging. Even if you know that INR will drop by only 8%, you still want to hedge because you want to be sure. :). but I guess we have to stick to the curriculum.

[MrSmart]

@crosstheevil

I find it strange that in some exercises, managers bizarrely know the directions and the degree (%) that the currency will move (either up or down) like they have some sort of crystal ball. I always thought that you have to hedge the unknown - you can’t be too sure, that’s the purpose of hedging. Even if you know that INR will drop by only 8%, you still want to hedge because you want to be sure. :). but I guess we have to stick to the curriculum.

In that case as stated above, you WANT to hedge according the CIRP, to lock in a 10% profit.

The other side of the equation is if you think that the currency will depreciate by more than the CIRP price, then you could hedge some, or all of your position.