A UK investor holds a portfolio of overseas equities and is concerned about the exchange rate risk. Which strategy could he use to mitigate this risk?
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A. B. C. D.C
The correct answer is C. Hedging.
Hedging is a risk management strategy that involves taking a position in a financial instrument to offset the risk of price movements in another financial instrument. In this case, the UK investor holds a portfolio of overseas equities and is concerned about the exchange rate risk. Exchange rate risk refers to the risk that the value of the foreign currency in which the equities are denominated will change relative to the investor's home currency, the pound.
To mitigate this risk, the UK investor can use a hedging strategy that involves taking a position in a financial instrument that is designed to offset the risk of exchange rate movements. For example, the investor could use a currency forward contract, which is an agreement to exchange one currency for another at a fixed exchange rate on a future date. By entering into a currency forward contract, the investor can lock in the exchange rate at which the foreign currency will be converted into pounds, reducing the impact of exchange rate fluctuations on the value of the overseas equities.
Arbitrage is a trading strategy that involves taking advantage of price differences in different markets for the same asset. It is not a strategy that is typically used to manage exchange rate risk.
Gearing is a strategy that involves borrowing money to invest, in order to increase the potential return on investment. It is not a strategy that is typically used to manage exchange rate risk.
Pound cost averaging is a strategy that involves investing a fixed amount of money at regular intervals over a period of time. It is not a strategy that is typically used to manage exchange rate risk.