Price moves in the currency markets can be disruptive and lead to large losses with investors and corporations. In general, institutions do not protect themselves against this risk, because the cost of hedging is high. In this post, I try to explain how dynamic hedging improves the cost structure and makes hedging appear indispensable.
Currency risk is incurred, whenever assets or liabilities are denominated in a foreign currency. Liabilities are the opposite of assets and can basically be hedged in the same way as assets. Assets, just as liabilities, can be of any shape or form; they can be financial instruments, fixed assets, such as a house or factory; or an income or payment stream, for example pension receipts or payments for project work. Whenever the foreign currency appreciates, the value of the respective asset increases, whenever the foreign currency drops, so does the value of the asset. (more…)