Assessing Currency Overlay Strategies

Very Hard Currency Management Currency Overlay

XYZ Asset Management has a global equity portfolio valued at $2 billion, primarily invested in North American equities. The firm employs a currency overlay strategy to hedge the foreign exchange risk inherent in its international investments. Recently, the USD has appreciated against several major currencies, including the Euro and British Pound. As part of its currency overlay, the firm has identified three potential strategies:

1. Establishing a long position in Euro and British Pound forward contracts to lock in current exchange rates.

2. Implementing a dynamic hedging approach that adjusts exposures based on market volatility and currency forecasts.

3. Using options to hedge without taking on directional risk, thereby retaining upside potential in currency movements.

Given this information, which of the following statements regarding the currency overlay strategies employed by XYZ Asset Management is most accurate?

The long position in Euro and British Pound forward contracts minimizes currency risk but eliminates all upside potential.

The dynamic hedging approach is superior as it allows responsiveness to market conditions and can capture upside without incurring high cost.

Using options for hedging exposes the portfolio to significant downside risk compared to forwards.

Hint

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