Optimal hedging

The article, 'Optimal Hedging and Foreign Exchange Risk', by Nancy Beneda, illustrates the technique of computerized optimization and ..... modeling to manage foreign exchange risk, and the results indicate that a lower level of risk can be achieved, given a specified level of expected hedging cost, from using optimization modeling.

The focal point of the technique is its ability to identify optimal combinations of hedging ..... (i.e. futures, options, forward contracts, leaving the position open).

An optimal combination is one which minimizes the ..... of the expected cost of the commodity (i.e. foreign currency), given a desired level of hedging cost.

This paper examines optimal hedging strategies for a ..... position in the Japanese yen/US$ foreign exchange market.

In the ..... of this paper, the expected hedging cost is the expected cost of the commodity (i.e. foreign currency) using a specified hedging strategy minus the expected cost of the foreign currency when the position is left open.

The technique is similar to achieving optimal portfolios: portfolio theory suggests that optimal allocations of ..... of money exist which minimize the standard deviation of the portfolio for any targeted expected return.

The optimization methodology increases the hedger's range of choices, and in this way risk managers will have the information needed to choose the desired level of foreign exchange risk which fits ..... the firm's overall risk strategy.

Being able to more accurately measure the total risk which a firm faces will result in a better understanding of the extent to which the firm will be able to handle new ..... projects.

Risk-return analysis suggests that the amount of gain expected from investing is ..... related to the level of risk incurred.

If this concept is applied to hedging, the more risk a hedger is willing to ....., the more gain potential from favorable market conditions there will be for the hedger, and the lower the expected hedging cost.