Forward Currency Research Articles

Optimal hedging with currency forwards, calls, and calls on forwards for the competitive exporting firm facing exchange rate uncertainty

We extend the well-known full hedge theorems of the hedging literature to random profits that are nonlinear in the random exchange rate. This arises when production flexibility is added to the standard model of the risk-averse exporting firm, where all production decisions have to be made before the exchange rate is known. Hence, hedging with currency derivatives that provide a linear payoff in the exchange rate can no longer provide a perfect hedge. Therefore forward selling is replaced by writing a certain call portfolio. Adding delayed revenue to the model induces the firm to sell calls on forwards. Because our generalized full hedge proposition is proved for random profits that might as well decrease in the exchange rate, the result is applicable to certain types of importing firms, too. — Given the absence of speculative motives on the part of the firm, it turns out that long-term investments in capital goods are chosen in risk-neutral manner.

Real and Monetary Shocks and Risk Premia in Forward Markets for Foreign Exchange

A version of the model of Lucas (1982) and Domowitz and Hakkio (1985) is used to compute risk premia on forward foreign exchange from stochastic shocks to goods and money. Risk premium signs and magnitudes vary with shocks and with the intratemporal substitutability of goods in consumption. When the elasticity of substitution is less than (greater than) one, an increase in home good variance induces a decrease (increase) in the risk premium on forward foreign currency. When money is the source of shock, no risk premia appear. A premium can appear unrelated to risk but caused by a 'Jensen's inequality effect.' Copyright 1993 by Ohio State University Press.

Expected utility and the siegel paradox: A generalization

It was recently shown by Sinn that, under certain conditions, because of the Siegel paradox, even risk-averse agents can find speculation on forward currency markets attractive. His assumptions are that the spot and forward rates are identically distributed and statistically independent and that the agents' coefficients of relative risk aversion are constant and inferior to unity. We show that both assumptions of statistical independence and constant relative risk aversion can be dramatically relaxed.

Tax wedges, bid-ask spreads, and international financial parity conditions

Tax wedges do not induce a priori inconsistencies in the international Fisher effect nor do they render forward rates biased predictors of future spot rates once proper account is taken of the bid-ask spreads present in spot and forward foreign currency transactions.

International investments and exchange rate risk

In this paper we consider a risk-averse multinational firm under exchange rate risk. We analyze the impact of exchange rate risk and of the use of currency forwards on the firm's global market decisions with respect to international firm-specific capital allocation and direct foreign investment. A rise in exchange risk lowers the holdings of foreign real assets provided that there are no external hedging instruments. However, when forward market exist, the firm's optimal holdings of foreign assets are independent of its attitude towards risk. Furthermore we show that direct foreign investments are increasing with the introduction of forward markets if firm- specific capital and direct investments are complementary factors.

International portfolio diversification: the basket-peg regime

The paper compares and contrasts optimal investment strategies in two alternative monetary arrangements, namely, in the regime with freely floating bilateral exchange rates and the basket peg system. It is shown that in the basket-peg arrangement investors can form a domestic currency denominated risk-free asset of the foreign risk-free assets without entering into the forward currency markets. Furthermore, investors have an incentive to hold fewer assets and the structure of capital flows tends to be more volatile but also more predictable in the basket-peg system than in the regime with freely floating bilateral exchange rates.

The profitability of forward currency speculation by central banks: A comment

The article by Beenstock and Dadashi (1986), which tries to examine the profitability of the forward currency operations of the Canadian Exchange Fund Account, is misleading in two ways. First, its longer sample period mixes forward contracts entered into during a fixed exchange rate period (contracts which proved unprofitable) with contracts from the flexible exchange rate period. Second, it assumes that the net forward position reflects entirely forward contracts and not ‘overnight’ spot transactions. Official reports and econometric evidence show that the latter transactions predominated.

The profitability of forward currency speculation by central banks

A methodology is proposed to convert stock data on a central bank's official forward position in the foreign exchange market into flow data regarding its purchases and sales of forward exchange over time. The flow data enable us to determine whether the central bank's forward currency operations have been profitable or not. The methodology is applied to the forward currency operations of the Bank of Canada. We find that on the whole the Bank of Canada did not make systematic profits or losses on its operations.

Inflation, currency exchange rates, and the international securities markets

A time-state-preference model of an efficient and complete international financial market is employed to investigate the conditions under which the international Fisher Effect will hold, and the forward currency exchange rate will be an unbiased estimate of the future spot rate. The presence of stochastic inflation within countries in the fiat-currency prices of real goods will destroy both relationships, even in the absence of any institutional imperfections or trading barriers. Similarly, expected inflation rate differentials across countries will not coincide with spot-versus-forward currency exchange rate differentials.

Non-ferrous metals and ferro-alloys: forecasting, forward currency cover, and purchasing tactics and strategy

Abstract It is argued that all companies for which non-ferrous metals and ferro-alloys are an important determinant of production costs should establish a Materials Working Group to help protect profitability. Such companies must examine their critical materials, calculating the impact of major fluctuations, and cover them by inventory, contracting, or forward-purchasing adjustments. This will involve making assumptions about world growth rates and changing exchange rates, and using markets such as the London and New York metal exchanges. A simple forecast is presented of changes in metal prices and exchange rates for 1982–83. Ways of establishing a Materials Working Group and making it effective are suggested.

Managing currency risks–buy or sell forward

“Forward currency deals” - a creative and proven method for managing and containing the risks associated with projects involving payments and receipts in several currencies. The systems and disciplines involved in this interesting and vital speciality require great numeracy and forecasting skills from cost engineers, managers and planners.

Forward Exchange Price Determination in Continuous Time

The work of Black and Scholes [2] and Merton [4] suggests that analysis of hedged positions in a continuous time random walk model yields powerful insights into the valuation of financial securities. The present paper extends this methodology in a straightforward fashion to foreign exchange transactions. By adopting the device of hedging in a secondary market for forward currency contracts against a long position in spot currency, a simple statement of boundary conditions for the forward position can be detailed. This allows a direct solution of the continuous time valuation problem that yields the interest rate parity theory.

The Role of Expected Value Analysis for Speculative Decisions in the Forward Currency Market

I. Introduction, 157. — II. Expected profits and the generalized mean, 159. — III. A comment on Siegel's analysis, 165. — IV. Expected value analysis in other areas of economics, 168.

Forward Exchange and Currency Position

Forward Exchange and Currency Position