The most important risk to Bjrks Latin American currency hedge would be changes in: A. forward points.

The most important risk to Björk’s Latin American currency hedge would be changes in:

A. forward points.

B. exchange rate volatility.

C. cross-currency correlations.

Rika Björk runs the currency overlay program at a large Scandinavian investment fund, which uses the Swedish krona (SEK) as its reporting currency. She is managing the fund’s exposure to GBP-denominated assets, which are currently hedged with a GBP 100,000,000 forward contract (on the SEK/GBP cross rate, which is currently at 10.6875 spot). The maturity for the forward contract is December 1, which is still several months away. However, since the contract was initiated the value of the fund’s assets has declined by GBP 7,000,000. As a result, Björk wants to rebalance the hedge immediately.
Next Björk turns her attention to the fund’s Swiss franc (CHF) exposures. In order to maintain some profit potential Björk wants to hedge the exposure using a currency option, but at the same time, she wants to reduce hedging costs. She believes that there is limited upside for the SEK/CHF cross rate.
Björk then examines the fund’s EUR-denominated exposures. Due to recent monetary tightening by the Riksbank (the Swedish central bank) forward points for the SEK/EUR rate have swung to a premium. The fund’s EUR-denominated exposures are hedged with forward contracts.
Finally Björk turns her attention to the fund’s currency exposures in several emerging markets. The fund has large positions in several Latin American bond markets, but Björk does not feel that there is sufficient liquidity in the related foreign exchange derivatives to easily hedge the fund’s Latin American bond markets exposures. However, the exchange rates for these countries, measured against the SEK, are correlated with the MXN/SEK exchange rate.
(The MXN is the Mexican peso, which is considered to be among the most liquid Latin American currencies). Björk considers using forward positions in the MXN to cross-hedge the fund’s Latin American currency exposures.