The portfolio has a long exposure to CHF 10,000,000 . To hedge it the portfolio manager sold CHF forward. 1 month later, the value of CHF is 11,000,000 , so to rebalance it as per dynamic hedging we will sell additional CHF 1 million to increase the hedge.
Now, when it comes to currency we over hedge if the currency is expected to depreciate and under hedge if we expect it to appreciate (to capture the upside potential of currency). But why not do the same thing for the asset exposure above?
I might be thinking too much , or I have it all mixed up. But its confusing the hell out of me. Someone kindly help .
You can certainly over-/underhedge in your example and keep some of the CHF exposure if you want to. It just depends on your goal.
So in exam we are supposed to solve as per the curriculum way only , right?
I would only use over-/underhedging in any question if this is explicitly required by the vignette. Otherwise hedging should mean a complete hedge.
Okay. Perfect. Thanks and best of luck!
It’s weird in currency land versus equities/options, but if you think that rates are going to decline, you would want to BUY MORE contracts (because you want the BPVA to benefit from rates going lower). If you think that rates are going up, you would buy FEWER contracts (because you wants the BPVA to not hurt as much from rates going higher).
Nf for 110% hedge for when rates go lower.
Nf for 90% hedge for when rates go higher.
***REMEMBER: Don’t think of ‘hedge’ in the traditional sense as in ‘protection.’ If rates are going lower, we want to over hedge by buying more contracts! If rates are going higher, we want to under hedge by buying fewer contracts.***
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