I had a small doubt in the executing the hedge part in currency management. The part is of page no. 345 in the curriculum ( VOL 3). What i dont get is the Hedge #2.
[content removed by moderator]
I understand the First part since the exposure in EURO goes up; we have to increase the long position. But I dont understand the currency depreciation part [What is the viewpoint; we are looking at the base currency perspective. If yes, how does the fall in the exchange rate affect me as an investor.]
Logic is simple. Domestic currency return is based of foreign asset return (appreciation/depreciation of asset value) and foreign currency return (appreciation/depreciation of currency in which particular foreign asset is quoted). If you expect that unfavorable foreign currency movements may significantly jeopardize your overall return (domestic currency return), hedging might be an optimal choice.
If the cost of hedging (eg. price of FW contract) is quite more than depreciation of foreign currency you expect, you will simply decide that you wouldn’t hedge your position. Otherwise, hedging cost would decrease domestic currency return quite more than simply do nothing strategy. Hedging may be taken in both direction given to your position (foreign asset/liability) and given to your expectation as investor.