Cross Hedge

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doobsmeister

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I am trying to understand the concept of cross hedge. Is it simply hedging by using other unrelated instruments? For instance, buying gold and selling silver.
Trying to undertsand the concept. Thanks.
 
Not unrelated instruments, they are using instruments which have similar price movements. Basically done to limit the upside and the downside.
 
ok… what is the difference between that an a normal hedge then?
 
Cross here refers to the point that, you are using a related instrument and not the same instrument (or a derivative of the instrument) in itself.
 
Suppose that your home currency is the BRL (Brazilian real) and you have a large payment coming in THB (Thai bhat). You’d like to hedge the exchange rate risk, but there are no BRL/THB forward contracts available. However, there is a strong, positive correlation between the price of THB and the price of CNY (Chinese yuan), and there are BRL/CNY forwards available, so you hedge using one of those forwards.
That’s a cross hedge.
 
What i find more subtle is the difference between Proxy Hedge and Cross Hedge. i think i have seen one or two past mocks on this.
 
The current reading doesn’t distinguish between a cross hedge and a proxy hedge.
In the example I gave, some authors would call hedging with BRL/CNY forwards a proxy hedge and hedging with THB/CNY forwards a cross hedge.
At the moment, you needn’t worry about the (terminological) difference.
 
S2000magician wrote:
Suppose that your home currency is the BRL (Brazilian real) and you have a large payment coming in THB (Thai bhat). You’d like to hedge the exchange rate risk, but there are no BRL/THB forward contracts available. However, there is a strong, positive correlation between the price of THB and the price of CNY (Chinese yuan), and there are BRL/CNY forwards available, so you hedge using one of those forwards.
That’s a cross hedge.
Click to expand...
I was searching for this term ‘positive correlation’ while asnwering (instead used the term related instrument)! You magician sir are awesome! (thats between business as usual for magician though :))..
 
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