Cross Hedge and Proxy hedge

Proxy hedge is using an alternate foreign currency to hedge the currency risk thats different than the currency of your actual investment. Cross hedge is where you use a contract to hedge the local currency against an alternate foriegn currency, then hedging the alternate foreign currency against your domestic.
 
dtrynoski - not too sure the last part is certain.
Cross hedge would simply be converting currency risk from one foreign currency to another foreign currency - good if you have a view that another foreign currency will be appreciating more than the market suggests.
Proxy hedge is used if the foreign currency hedges are expensive or not widely available hence you can use another foreign currency which you have reason to believe has a high correlation.
proxy - use alternative currency hedge as a ‘proxy’
cross - swap the currency exposure to another foreign currency exposure.
 
sk22 Wrote:
——————————————————-
> dtrynoski - not too sure the last part is certain.
>
> Cross hedge would simply be converting currency
> risk from one foreign currency to another foreign
> currency - good if you have a view that another
> foreign currency will be appreciating more than
> the market suggests.
>
> Proxy hedge is used if the foreign currency hedges
> are expensive or not widely available hence you
> can use another foreign currency which you have
> reason to believe has a high correlation.
>
> proxy - use alternative currency hedge as a
> ‘proxy’
> cross - swap the currency exposure to another
> foreign currency exposure.
For a cross hedge you’re entering into two separate contracts because there isn’t a contract available with the two currencies you need.
 
from my understanding a cross hedge does not need to involve 2 separate contracts and hence does not need to result is ZERO foreign currency exposure. But yes using 2 contracts to get around the problem of no single contract would also be deemed a cross hedge. (imo)
 
sk22 Wrote:
——————————————————-
> from my understanding a cross hedge does not need
> to involve 2 separate contracts and hence does not
> need to result is ZERO foreign currency exposure.
> But yes using 2 contracts to get around the
> problem of no single contract would also be deemed
> a cross hedge. (imo)
Based on what I’ve read in CFA, that’s what they’re referring to. Was there something in a particular reading that contradicts the two contract statement?
 
lets say ur a usd investor and hold kazakistan bond…………………..
a forward hedge would be using a forward hedge between the KZD and the USD
a cross hedge would be a hedge between the KZD and EUR
a proxy hedge would be a hedge between the USD and the EUR
 
pimpineasy Wrote:
——————————————————-
> lets say ur a usd investor and hold kazakistan
> bond…………………..
>
> a forward hedge would be using a forward hedge
> between the KZD and the USD
> a cross hedge would be a hedge between the KZD and
> EUR
> a proxy hedge would be a hedge between the USD and
> the EUR
See, I disagree with this. A cross hedge would mean entering into KZD and EUR and entering into USD and EUR at the same time because USD/KZD is not available.
Do you have a reference in the curriculum?
 
This sounds similar to what I mentioned above, except they didn’t mention the transactions you have to enter:
cross hedging refers to hedging using two currencies other than the home currency and is a technique used to convert the currency risk of the bond into a different exposure that has less risk for the investor. The investment policy statement often provides guidance on permissible hedging methods.
(Level III Volume 4 Fixed Income and Equity Portfolio Management , 4th Edition. Pearson Learning Solutions 134).
 
bpdulog Wrote:
——————————————————-
> This sounds similar to what I mentioned above,
> except they didn’t mention the transactions you
> have to enter:
>
> cross hedging refers to hedging using two
> currencies other than the home currency and is a
> technique used to convert the currency risk of the
> bond into a different exposure that has less risk
> for the investor. The investment policy statement
> often provides guidance on permissible hedging
> methods.
> (Level III Volume 4 Fixed Income and Equity
> Portfolio Management , 4th Edition. Pearson
> Learning Solutions 134).
>
bpdulog- I don’t think you are correct, it clearly says cross hedging is hedging two currencies other than the home currency(No home Currency used) and is a technique used to convert the currency risk of the bond into a different exposure. Pimpineasy has the right example.
 
can we have some more people chime in here ……………..it was briefly mentioned but there is some confusion…………………someone please plug back in CPK
 
In the context of currency hegdge
• Proxy hedge: Forward contract between domestic currency and a second foreign currency that is correlated with the first foreign currency
• Cross hedge: forward contract to deliver original foreign currency for a second foreign currency –> *CHANGE* your currency exposure to the second foreign currency
Note that the CFAI use the term cross hedge also in the commodity hedging. In this case, cross hedge means the same as proxy hedge in currency hedging!!!
I.e., cross hedge in the commodity hedging context: hedging the position with a similar commodity which has correlation close to the commodity you want to hedge.
Long 410,000 gallons of heating oil –> you cross hedge by using (crude) oil futures. Crude oil futures have high correlation with your heating oil position. Because the correlation is high but not perfect (i.e., R2 <1), the hedge gives a lot basis risk.
 
Example of Cross Hedge
Company based in Singapore (local currency) has sales in Europe (euro exposure), it hedges using Euro - USD contract (sell euro/USD forward) assuming Singapore Dollar is more or less pegged to USD and since Euro - SGD contracts are not available.
Does this make sense?
 
As far as I remember:
Lets say I’m UK investor with a INR bond
CROSS HEDGE: Would be INR vs another CCY, then I COULD do a CCY vs GBP hedge, but this is not necessary in a cross hedge, as I choose another CCY that is close to GBP
PROXY HEDGE: I know that JPY/EUR is highly correlated with INR/GBP so I hedge with that
 
I shouldn’t have come to this thread. I understood the difference, now I am confused!
 
Here are some example:
Proxy hedge:
US (USD local currency) company has exposure in Danish Krone. Since the Danish Krone is pegged to the EUR and it is cheaper to do a hedge in EUR, the company would buy a forward (sell EUR and buy USD) to more or less offset its DKK exposure.
Characteristics of proxy hedge:
- Significant hedging out the exposure since the new currency you choose as a proxy (EUR) has very high correlation with the currency you want to hedge (here DKK) so you are left with (small) basis risk.
Cross hedge:
Same company same DKK exposure, but it chooses now to buy a DKK/British pound forward contract (sell DKK and buy British pound). With this forward, it essentially convert the DKK exposure to a British pound exposure.
It does this because of various reasons:
- It feels more comfortable with BPD exposure than DKK exposure (e.g., more correlation btw USD and BPD, feell BPD is not volatile,…)
- It may have some (unrelating) offsetting CF in British pound (for example it must pay some contractors in British pound) thus providing a natural hedge.
Characteristics of proxy hedge:
- It is not a hedge actually, more a conversion of currency risk from one foreign currency to ANOTHER foreign currency. The risk is still (more or less) there but you manage it through other means.
Hope it is clearer.
 
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