- March 7, 2022 at 3:59 pm #650075meerurajMember
- Topics: 29
- Replies: 24
Im confused with the forward rate that should be used when it is over hedged or underhedged pls explainMarch 8, 2022 at 8:36 am #650169John MoffatKeymaster
- Topics: 57
- Replies: 51552
It depends on whether they are hedging a receipt of a foreign currency or a payment of a foreign currency.
If it is a receipt of a foreign currency then if they have over-hedged they will be covering conversion of more of the currency than they will actually be receiving and therefore they need to use the forward rate to buy more of the currency in order to fulfil the futures deal.
If they have under hedged then they will need to sell the extra foreign currency at the forward rate.
It is the same logic but the other way round if it is a payment of a foreign currency.
(Dealing with an over or under hedge is a minor point in the exam worth very few marks. Most of the marks are for proving that you understand how futures work, and just mentioning the possibility of using forward rates on any over or under hedge (without doing extra calculations) will get almost all of the marks.)
- You must be logged in to reply to this topic.