This paper examines the benefits from hedging the currency exposure of international investments in single- and multi-country equity and bond portfolios from the perspectives of German, Japanese, British and American investors. Over the period 1975 to 2009, hedging of currency risk substantially reduced the volatility of foreign investments at a quarterly investment horizon. Contrary to previous studies, the paper finds that at longer investment horizons of up to five years the case for hedging for risk reduction purposes remained strong.In addition to its impact on risk, hedging affected returns in economically meaningful magnitudes in some cases.

Foreign currency exposure is a by-product of international investing. When obtaining global asset exposure, investors also obtain the embedded foreign currency exposure. Left unmanaged, this currency exposure acts like a buy-and-hold currency strategy, which receives little or no risk premium and adds unwanted volatility. In “Some Like It Hedged,” the author shows that the impact of foreign currency exposure on institutional portfolios depends significantly on the base currency of the investors and the specific composition of their portfolios. In general, investors whose base currency is negatively correlated with global equities, as are the US dollar and the Japanese yen, will reduce the volatility of their portfolios by fully hedging foreign currency exposure. In contrast, investors whose home currency is positively correlated with global equities, as is the Canadian dollar, will benefit from keeping some unhedged foreign currency exposure—in particular, exposure to the US dollar. Finally, investors with larger allocations to domestic assets will experience only small reductions in volatility from hedging. Pojarliev discusses a variety of options to address foreign currency exposures. Although there is no single best-practice solution for addressing foreign currency exposures, institutional investors have three main choices. Do nothing (i.e., maintain unhedged foreign currency exposure). Doing nothing is always the easiest option, but from a risk–return perspective, it could be the worst available choice. Currency has no long-term expected return because, although it is a risk exposure, it is not an economic asset. Hence, long-term currency returns are expected to be zero. Hedging should, therefore, have no long-term impact on the return and only affect the volatility. The volatility reduction from hedging can be redeployed more efficiently by increasing exposure to economic assets for which a risk premium exists. Hedge passively (i.e., maintain a constant hedge ratio).In general, hedging some of the foreign currency risk will decrease the volatility of the portfolio. The relationship between a specific hedge ratio and the decrease in volatility depends on the particular portfolio and, most importantly, on the base currency of the investor. Yet, passive hedging creates its own problems, including negative cash flow generation when foreign currencies are appreciating and detraction from returns because of hedging costs. Passive hedging might also introduce a major market-timing risk. If the base currency weakens after a passive policy is implemented, the investor will suffer substantial hedging losses when the forward currency hedging contracts settle. Hedge actively (i.e., vary the hedge ratio). One way to address the market-timing risk of implementing a passive hedging program is to actively time the hedging of the foreign currencies. An active hedging program seeks to reduce the risk of the foreign currency exposure but varies the hedge ratios for the various currencies based on market views to avoid negative cash flow and to generate positive returns. A successful active hedging program should both add to the return of the portfolio and lower the volatility, and it should outperform both an unhedged and a passive hedging benchmark. The best choice to address foreign currency exposure will differ from institution to institution, but it boils down to two fundamental factors. First, the optimal solution depends on the importance of risk versus return and the institution’s tolerance for negative cash flow. Second, investors must decide whether they believe that currency managers are able to achieve a positive information ratio over the long run after fees and, importantly, whether they will be able to identify these currency managers. Any currency policy will depend on the details of the specific portfolio—in particular, on the base currency of the investor and the size of the foreign currency exposure.

This title provides a forum for the discussion surrounding the use of currency hedging for portfolio managment and examines the arguments for the different hedging techniques. The main arguments are outlined with contributions from both academics and practitioners. The evidence on the performance of various funds is examined in detail.

� Fully updated version of text formerly used for training by BPP � Diagrammatic representation of deal structures, pricing, and modeling � Full glossary of terms � International perspective, examples in US$ � Clear logical explanation of processes, markets, and products This manual explains the techniques for identifying and covering exposure to adverse movements in foreign exchange rates. It provides practical examples of transaction, translation, and economic risk and shows how a hedging strategy can be arrived at. The hedging strategy will depend upon whether the attitude to risk is adverse, seeking, or neutral. This book examines these attitudes in turn and compares these hedging methods through worked examples. Also included is an analysis of accounting and tax implications. This expansive new range of risk management texts has undergone extensive re-writing to give each book in the series an international perspective. Each explains and analyses core aspects of risk assessment and management in a way invaluable to students and useful to practitioners. All of these titles adopt a practical and clear approach to their subject. All are fully updated versions of a series of books previously produced by training experts at BPP.