Hedging Foreign-Currency Risk in Bond Portfolios
Summary
The document outlines ways to hedge the exchange-rate exposure of a bond portfolio whose cash flows are received in a foreign currency. The hedge is intended to gain value when that currency weakens against the investor’s base currency, offsetting the translated loss on the bond. It names FX swaps and forward contracts as possible instruments, and notes that an FX future can serve a similar role. A forward sets an exchange rate for a future currency exchange; its rate depends on spot and short-term interest rates in the two currencies.
The material also points readers to articles and books for deeper study, but those references are suggestions rather than evaluated evidence. The instrument descriptions are introductory and do not address hedge ratios, rolling positions, basis, transaction costs, collateral, or the bond portfolio’s changing cash flows. The appropriate hedge therefore depends on exposure details and implementation choices not developed here.
Key ideas
- A currency hedge can offset translation losses when the bond’s receipt currency weakens against the investor’s base currency.
- An FX swap can be structured to gain when the currency received from the bond loses value.
- A forward or similar futures position can take a short position in the bond’s receipt currency.
- Forward rates reflect spot exchange rates and short-term interest rates in the two currencies.
- The document offers introductory instruments and references but does not specify hedge sizing or implementation.
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Full text
# Bond portfolio hedging against currency risk # Bond portfolio hedging against currency risk How do I hedge a bond portfolio against currency risk? Ideally I'm looking for books or other references on this topic. ## Answer by Chris Andy (score 2) https://quant.stackexchange.com/a/25565 This is a resource you may want to look at. https://personal.vanguard.com/pdf/ISGHC.pdf Additionally, this books seems good for this particular topic: Risk Without Reward: The Case for Strategic FX Hedging. Also, take a look at Advanced Bond Portfolio Management: Best Practices in Modeling and Strategies edited by Frank J. Fabozzi, Lionel Martellini, Philippe Priaulet ## Answer by AfterWorkGuinness (score 1) https://quant.stackexchange.com/a/21411 The idea is you want the hedge to benefit when the bond's currency weakens against the currency you will be exchanging it for. A couple ways are: - Enter into an FX swap where you pay in the currency you are receiving on the bond and receive another currency. If the currency you are receiving on the bond weakens, you will lose on the bond but gain on the swap. - Buy and FX forward (or similar an FX future) where you are short the currency you are receiving in the bond. Again, when that currency weakens, your hedge position will gain. These are just a couple simple points on a deeper underlying topic. ## Answer by iNarek94 (score 0) https://quant.stackexchange.com/a/21404 Take a look at this article. Also, there is a good reference list in the end. ## Answer by Alex C (score 0) https://quant.stackexchange.com/a/21412 Quote: Currency hedging is most commonly carried out with forward contracts, which are agreements with a counterparty to buy or sell one currency against another at a pre-specified exchange rate and time. The agreed upon exchange rate (the forward rate) is a function of the existing spot rate and short-term interest rates in the hedged and base currency. EndQuote. Source: A Short Course in Currency Overlay. An article I like is Currency Hedging for International Portolios: https://www.imf.org/external/pubs/cat/longres.aspx?sk=23994.0
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