Explain techniques that cut the cost of hedging and alter the risk and return profile of a portfolio holding foreign-currency assets
The idea
Forwards cost nothing upfront but give up all currency gains; options keep upside for a premium, which can be trimmed. Out-of-the-money puts are cheaper than at-the-money ones but leave a deductible. A collar funds the put by writing a call, capping gains. A put spread writes a lower-strike put against the bought one, so protection stops below that strike. A seagull adds a written call to a put spread, reaching near-zero cost. Knock-in or knock-out features cheapen protection further, and deliberately over- or under-hedging with forwards is another lever. There is no free saving: each cut in premium means accepting some risk or surrendering some upside, so the choice must fit the client's view and tolerance.
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Take the free diagnostic →More in Currency Management: An Introduction
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- Explain the strategic decisions available in managing currency exposure
- Design a suitable currency management programme in light of market conditions and the portfolio's objectives and constraints
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- Explain how shifts in the drivers of active currency strategies alter tactical positioning
- Explain how hedge ratios are adjusted using currency forwards and foreign exchange swaps
- Explain the role of minimum-variance hedge ratios, macro-hedges and cross-hedges for portfolios exposed to several foreign currencies
- Explain the difficulties of managing currency exposure in emerging markets