Application of Derivatives - Wintermantle

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MrSmart

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Using a three-month futures contract on the Nikkei 225 Index that is currently valued at JPY8,935,000….Cai agrees with Wintermantle but expresses concern about unfavorable moves in the value of the Japanese yen. He asks whether it would be possible to completely hedge foreign currency risk. Wintermantle responds that in order to fully hedge yen currency risk, he would need to hedge foreign equity market exposure as well as the currency exposure.
How would he hedge equity exposure to fully hedge its currency risk, if the equity exposure was done through longing a JPN Gov bond and the index future?
 
Not sure really what you’re asking, but he’d need to know the ending value of the index to be able to determine how much currency exposure to hedge.
 
cook29 wrote:
Not sure really what you’re asking, but he’d need to know the ending value of the index to be able to determine how much currency exposure to hedge.
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True, but if you’re already long the index with futures, then how are you going to fully hedge the currency risk?
 
Is Wintermantle’s response to Cai’s question about fully hedging Japanese yen currency risk most likely correct
A) No, he is incorrect about hedging currency risk
B) Yes
C) No, he is incorrect about hedging foreign equity market exposure
Correct answer is B)
To fully hedge currency risk, both the foreign equity market exposure and the currency risk must be hedged. Cai is long the Nikkei and the JPY. To completely hedge currency exposure, Cai would need to know how much JPY to deliver in the future, but this amount is unknown and dependent on the Nikkei’s future value. The only way to know this amount now would be to hedge exposure to the Nikkei by using Nikkei futures to lock in the amount of JPY to be delivered in the future.
 
Yeah so I guess it’s all hypothetical. Seem’s like a pointless concept though - can’t actually do it.
 
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