Hi Can anybody contrast these 2 types of hedging techniques (with reference to currency hedging). Thanks!
Currency hedge: you hedge using two foreign currencies (home currency is not involved). basically a way to transfer risk rather than hedging risk. Proxy hedge: you hedge using investor’s home currency and a foreign currency highly correlated with currency in which the foreign bond is denominated.
I’d like to figure this out as well, since i can’t really seem to figure out what the difference between these two is. I don’t think that response is quite correct, though… Schweser states that the cross hedge does involve the domestic currency.
lets say you are a US investor (USD is your home / domestic currency). you invest in a japanese bond (bond currency = YEN). you expect japanese bonds to perform well over the period but are not so optimistic about japanese currency or the YEN. but simultaneously, you are bulish on Korean WON currency that it’ll apprecaite over your investing horizon. so you wish to have returns from japanese bond but dont want exposure to YEN. So you enter into a proxy hedge and exchange YEN returns for Korean WON returns. this is proxy hedge.
lets say you are a US investor (USD is your home / domestic currency). you invest in a japanese bond (bond currency = YEN). you expect japanese bonds to perform well over the period but are not so optimistic about japanese currency or the YEN. but simultaneously, you are bulish on Korean WON currency (highy correlated with YEN) that it’ll apprecaite over your investing horizon. so you wish to have returns from japanese bond but dont want exposure to YEN. So you enter into a proxy hedge and exchange YEN returns for Korean WON returns. this is proxy hedge.
also what is normally called a proxy hedge in other markets, its called a cross hedge in currency market.
Assume you a long an asset held in foreign currency F and your domestic currency is D 1 Proxy Hedge sell E to convert back to D (E is another foreign currency that has strong correlation to F) 2 Cross Hedge sell F to convert back to C (C is a currency that has strong correlation to D) Draw sketch plotting C, D, E, F and arrows to illustrate better
Proxy hedge: A US investor has invested in Korean WON bonds. The investor is expecting WON to depreciate. To hedge this risk he needs to sell WON forwards but WON forwards are not available. The investor identifies another currency highly correlated with WON (i.e. Japanese YEN). He sell YEN forward. Later on expiry he converts WON into YEN in spot market and gets US$ from the forward transaction. His risk is hedged. Cross hedge (assuming in above example WON forwards are available and YEN is expected to appreciate against US$ and WON is expected to depreciate against YEN): The investor will sell Won forward against YEN and keep US$ exposure against YEN unhedged. If expectation turn out to be correct, the investor will convert WON to YEN at forward expiry (hedged) and convert YEN to US$ on the spot (gaining on currency movements).
hmmm, this isn’t my understand at all, the way I see it is a proxy hedge is a cross hedge, just in the currency market. Proxy you want to hedge koren currency but you can’t find a contract so you hedge Yen instead because its highly correlated. Cross hedge: You want to hedge soybean meal but can’t find the contract with the terms you need so you just hedge soybeans. Both these trades expose you to basis risk.
HAZYSKUNK you are taking about commodity forward cross hedge while rp77 is taking about currency forward cross hedge. rp is correct about proxy and cross hedge
>Cross hedge (assuming in above example WON forwards are available and YEN is >expected to appreciate against US$ and WON is expected to depreciate against YEN): >The investor will sell Won forward against YEN and keep US$ exposure against YEN >unhedged. If expectation turn out to be correct, the investor will convert WON to YEN at >forward expiry (hedged) and convert YEN to US$ on the spot (gaining on currency >movements). Sorry, just to clarify, you expect… * Yen to appreciate against USD, and * Yen to appreciate against WON (i.e. WON depreciate against YEN) Here you are buying Yen against WON. Is this because you expect YEN to appreciate more against WON than the USD?