RD 27- Eoc # 16. I do not understand this q at all.
I feel your pain, I butchered this question. It’s worded in a difficult way to follow. Essentially the two are a natural hedge, so they don’t really need to pursue any hedging strategies because a decline in one source of return will be offset but a gain in the other source. They speak about similar concepts of natural hedges in the currency section for reference.
Yea the wording is pretty confusing. Here is what I gathered from it:
"movements in world oil prices in US dollar terms and the US dollar value of the home country’s currency are strongly positively correlated" - This implies that oil prices and their home currency have strong positive correlation and essentially move together. Since this happens, hedging them may not be necessary because they don’t move against each other.
"A decline in oil prices would reduce the company’s sales in US dollar terms, all else being equal. On the other hand, the appreciation of the home country’s currency relative to the US dollar would reduce the company’s sales in terms of the home currency." - This implies that the quantity demanded and the total dollar value too would not change. What would change (due to the home country appreciating in value) is the amount the firm would get in sales measured in the home currency.
This one is especially tricky, please correct me if you find mistakes.
foreign currency and foreign asset returns are highly negatively correlated so there is less need for hedging (foreign asset return going down leads to foreign currency return going up and vice versa)