Covering Foreign Exchange Risks: Comment

Abstract

In a recent article, Jorge Calderon-Rossell [1] examines the cost of alternative methods for hedging foreign exchange risk and provides a framework for the manager to use in choosing between the two methods. Calderon-Rossell's analysis is based on an incorrect construction of the money market hedge which adds an uncertain element to the firm's position. The purpose of this comment is to indicate that the cost of cover as defined by Calderon-Rossell is certain for both hedging techniques and that a wellknown theorem of foreign exchange indicates clearly when one alternative is less costly than the other. That being the case, Calderon-Rossell's analysis of the choice of hedging technique decision is irrelevant. Calderon-Rossell uses the premium or discount as the cost of hedging. While that view is often encountered in the literature, it is not held by me. I prefer the argument that the cost of hedging is the difference between the forward rate and the expected future spot rate, but this issue is not addressed in this comment because it is not relevant to the point being made. Whichever cost of hedging is used, the costs of the alternative methods will (4) below holds. be identical if Equation