hi, Suppose I am an UK investor and have to pay $1000 US dollar in a future date. And the current exchange rate of £/$ is 2:1, how can I hedge the currency risk by using forward? Since I worry about £/$ fall, should I “short a pound current forward” , so that I could make a gain in the cash market as pound deprecate? Or, I should "long a dollar currency forward”, so that I could make a gain as dollar appreciated?
Not that I've given it much thought, but are they the same? Short £ forward is agreement to sell £ (presumably for US$) Long $ forward is agreement to buy $ (presumably for £) Need to be clear on both currencies in forward. I suppose it might be possible to have one of them being a notional combination of other currencies, but assuming my interpretation is correct, both will work. Need to pay in US$ so need to lock in rate to sell £ to buy $ in the future.
I think more than making a gain you should be trying to protect yourself against downside risk, i.e. making a loss. Suppose you have to pay the $1,000 in 30 days. You think that the currency might be 1:1 in 30 days. So you would go to an investment bank and agree to exchange £500 for $1,000 in 30 days, based on today's market rate. If after 30 days, the exchange rates is indeed 1:1, then you will exchange your £500 for $1,000 and use the $1,000 to make the payment. If you did not have the forward contract you would have to exchange £1,000 for $1,000. Finally, I think Didster is correct in saying that they are both the same. I'm thinking: am I buying dollars with pounds (treating dollars like a commodity) or am I selling pounds for dollars (treating pounds as a commodity). Makes sense or did I confuse you more?!?!
