Foreign Currencies in Thailand & Hedging

Foreign Currencies in Thailand & Hedging

This literature review is in support of a study of the factors related to the forward premium on foreign currencies in Thailand. Literature is reviewed in this chapter in relation to the factors that affect the level of a forward premium on currencies, and in relation to the various approaches employed in the prediction for forward values for currencies.

Hedging and the Need to Hedge Forward Currency Exchange Rates

Hedging is an action or a series of actions taken by either a buyer or a seller to protect assets against a change in prices (Rees, 1991, p. 210). In practical applications, the concept of hedging works much like the concept of arbitrage.

William Sharpe (1991, p. 569) noted that, when two race horse enthusiasts bet with one another, the activity is termed gambling, and a risk has been created where none existed before the bet was made. When the owner of a horse in a race makes a bet on another horse in the same race, however, the situation is different, with respect to risk. In this latter instance, risk has been reduced through the application of hedging. In the race, if the owner’s horse wins, prize money will be collected by the owner, and the amount of money bet on the other (and losing) horse will be lost. If the owner’s horse loses, the owner will receive nothing in the way of prize money, but will receive the payoff on the bet on the other (and winning) horse. By betting on another horse in the same race, the owner has

reduced the amount that it is possible to make, should the owner’s horse win, but a complete absence of gain on the race, should the owner’s horse lose, is also avoided. Thus, by hedging, the owner of the horse has reduced risk, in the same practical manner as the hedger reduces risk and places boundaries on potential gains and losses in a set of transactions.

If a hedger is sufficiently skillful, risk can be fully hedgeda situation where the transaction will have no impact…

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