International Investments: Developing a Strategy to Manage Currency Risk
Jolanta Wysocka
Pros and Cons of Hedging Home and Foreign Currencies
Pro: Home and foreign currency hedging preserves a pension fund’s global value. When the home currency declines substantially against other currencies, value is added by buying foreign currencies to hedge this loss of value.
Con: Home and foreign currency hedging may deprive a pension fund of the benefit of diversification.
Appropriately addressing foreign currency risk is particularly important for funds investing internationally whose home currency is susceptible to illiquidity during financial crises Korean financial markets represent a small proportion of global capital markets, and demand for Korean won in foreign exchange markets is small relative to the real size of the Korean economy, Korean participation in world trade, foreign exchange reserves, and domestic institutional savings. Korean pension funds must therefore be careful about exchange rate risk when investing internationally. During the 2008–09 global financial crisis, the market for won became illiquid: deal size dropped to $5 million and the value of the won fell 61 percent versus the U.S. dollar (figure 4.61), making active currency management, which would have altered the currency hedge ratio from foreign currencies back to won, impossible.
Figure 4.61 Korean Won versus U.S. Dollar Won per dollar 1,600 1,500 1,400 1,300 1,200 1,100 1,000 900
Jan. 1, 2008
Apr. 1, 2008
Jul. 1, 2008
Oct. 1, 2008
Jan. 1, 2009
Apr. 1, 2009
Source: U.S. Federal Reserve.
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