Fund Managers Disagree on Value of Currency Hedging

By Aaron Lucchetti
2/1/01
Page C1
Discussion Questions

While choosing winning stocks may be the most important factor for managers of international stock funds, some fund managers have found significant benefits from hedging during the euros’ 19.6% decline last year. Other fund managers avoid hedging currency exposure, pointing to the increased transaction costs. Some analysts suggest that long-term investors may actually “welcome foreign-currency exposure to balance out” their dollar-denominated assets despite increased short-term volatility. Even though the shares might have earned an adequate return last year in euros, when the fund values were converted to dollars the value of these euro-denominated holdings were significantly reduced. Currency hedging involves using forward contracts to buy or sell the currency at a specified price and time in the future. If the currency depreciates, gains on the value of the contract can then offset a decline in the value of the fund.

DISCUSSION QUESTIONS:

What two things determine the performance of an international fund?
What effect did the 19.6% decline in the value of the euro last year have on U.S. mutual funds investing in euro-denominated stocks? Explain.

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What is a currency forward contract? How can the use of currency forwards minimize the vulnerability of international funds to declines in foreign currencies? Go to http://www.fortisbank.com.pl/services/Forward.html to find out more about forward contracts and see sample forward contract rates (actually current sample quotes are linked to this page). Note the bank’s statement regarding no additional charges for forward contracts. If so, how then does the bank make a profit on these contracts?
What are the disadvantages of currency hedging for international funds (that is, how can hedging potentially hurt fund performance)? Explain.
Why should investors care whether international fund managers use currency hedging? Is this information easy to obtain?
Some international fund managers hedge all of the time, while others either selectively hedge or do not hedge at all. What does this suggest about risk levels or volatility for these funds? Why would the investment horizon of fund managers and investors be a factor in the decision to hedge?
If you were an investor in an international fund, would you want the fund to hedge currency exposure? What might your answer depend on?
Assume that hedging adds value. If investors could hedge FX risk on their own account, would there be any benefit to investors from the mutual fund’s hedging for them? Support your answer. Can investors in fact hedge the FX risk faced by the fund as effectively as the fund can? Why or why not?
Why is currency hedging not an issue for investors in U.S. stock funds

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