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Hedging currency risk with a forward. Assume you are a US-based speculator and you want...

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Finance

Hedging currency risk with a forward.

Assume you are a US-based speculator and you want to bet on the UK 10 year zero nominal bond. Assume you buy the UK 10-year bond, but also need to hedge out your currency exposure (i.e. you do not want exposure to changes in the USD vs. GBP fx rate).

You decide to hedge your fx exposure by selling GBP 10 years forward.

You now how two legs to your trade: buy UK 10-year bond and sell GBP 10 years forward.

Question 1: describe your what market forces your overal bet is exposed to when you initially put the trade on? Essentially, what market forces will drive P&L?

Assume you don't need to describe how you funded the trade (i.e. how you got the USD to buy the bond is not in scope). Ignore counterparty risk, default risk, and bid/offer spreads. Assume everything settles on the trade date T. Only explain market forces when you initially put the bet on, not the entire life of the 10-years.

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