Long-Term Currency Trades

Discussion in 'Forex' started by rbartell, Dec 1, 2007.

  1. rbartell

    rbartell

    I am looking to synthetically adjust a portion of my assets out of the USD. I don't want to have much cash tied up because I want to stay in my current investments, so I don't just want to set up cash accounts in other currencies. My job also precludes me from investing in currency futures. My plan is to buy and hold FX using leverage at about 1/100 (to minimize the cash used). For example, if I own $1000 of stock ABC in USD, and then use $10 @ 1/100 leverage to get $1000 exposure to the Euro vs USD, I get stock ABC in Euros. Is this doable from an efficiency standpoint? In other words, fees or carry isn't so exorbitant that you wouldn't earn roughly the same return that interest rate parity would dictate? I don't mind paying transactions fees and maybe a service for providing data, but I don't want to be charged higher than market interest rates.

    If this is doable, are there any recommendations for the best brokers for these types of transactions?

    Thx.
     
  2. melo

    melo

    I'm not sure if you are looking to passively hedge against currency risk, or pursue what's termed an active currency overlay strategy (i.e. aim for positive returns on the FX element)

    Simplest and cheapest way to implement a passive currency hedge for a portfolio would be to utilise three-month forward contracts rolled continuously (assuming that the restriction on currency futures includes currency options). The forward rate reflects the interest rate differentials, and bid-offer spread should be no more than a few points.

    Most banks can handle this for you. Margin (collateral) probably 5-10% of the contract value, depending on your credit standing and the currency pair.
     
  3. You can check with Baron, but I do not think the word "broker" is allowed in your first 1000 posts here at ET. I could be wrong. I was wrong once in 1971.
     
  4. I don't understand your suggestion that your strategy will give the exposure of stock in EUR. What you'll get is the portfolio of $1000 worth of stock and $1000 invested in EUR. If your stock's price in $ remains flat and EUR rises by 10% against $ after closing your positions you have $1000 from selling stock and $1100 from selling EUR which is 5% increase of value ( $2100 / $2000 ) versa 10% increase in EUR against $. So you only had half of your stock position valued in EUR. Where I am wrong?
     
  5. melo

    melo

    As the OP said, 'synthetically'.

    If the stock ABC was, say, US-listed ADR of a european co. or eurozone ETF, then total return = return of asset + return of EUR vs.USD

    Pairing a EURUSD forward contract to that of a USD stock - in the same nominal amount - will synthetically produce the same return profile, less cost of the currency transaction - bear in mind that the FX contract only requires margin not full outlay, so your 10% currency gain is on, e.g. US$1050 total equity

    Of course, for a US-based investor with no international equity holdings, then this essentially making an unrelated FX bet...even more so now that the forward curve is pretty flat so little carry to enjoy after costs. Reasoning might be to diversify portfolio returns/risk.
     
  6. Another question arises how much economical sense it makes to invest into the assets of a foreign country if you believe that the currency of this country will depreciate?
    Is it worth taking the additional risk of offsetting your assets price risk by selling this currency using the huge leverage ( as I understand it's 20:1 in your example ) ?

    It would be more straight forward in my opinion to diversify out of the weak currency by buying the assets of the countries with the strong currency.
     
  7. melo

    melo

    The OP stated he didn't wish to sell out of existing holdings or allocate much cash to the strategy

    True, for most buy & hold private investors who don't wish to play the FX market, the simplest route to obtain currency diversification is to hold assets in that ccy.

    However, that then introduces the variability of the returns expected from that country's equities/bonds. (Appreciating ccy and equity market don't always go hand in hand, e.g. Japan recently)

    The leverage ratio isn't a significant risk in this example. Taking your suggestion of him investing directly in the overseas market, the investor would lose the same nominal sum on an adverse currency move.
     
  8. sim03

    sim03

    Bad, fatally flawed plan. Not doable, and efficiency, as you've described it, would be the least of your concerns.

    You can't just "buy and hold FX" at 100x leverage, period. Or even 10x. If that isn't obvious... when was the last time you pulled up a plain EUR/USD daily or longer chart?
     
  9. melo

    melo

    Depends on his margin:equity ratio, surely?

    His exposure might only be a small proportion of NAV.
     
  10. rbartell

    rbartell

    Thanks for all your suggestions.

    I had read that the smaller individual investor would have trouble finding counterparties. Based on your suggestion, I looked around some more and found a couple options out there.

    One question about the forward contracts: If I want a longer-term hedge, is the three-month still the best? (Because it's most liquid?)

    Just out of curiosity, what is the reason an actual levered currency position isn't the best (carry cost higher than efficient? etc.)? From a liquidity and lack of cash drag perspective the actual currency position seems to have the advantage with those two characteristics (not that they couldn't be quickly cancelled out by something else).
     
    #10     Dec 3, 2007