Flows and Woes: The True Costs of Spot Trading Policy

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Kawaller (1992) demonstrates the financial risk when there is a difference between the settlement dates of an international asset trade and the currency required for or generated from the asset trade.  We extend Kawaller’s work to equity portfolios with investor flows, finding that the foreign exchange risk becomes levered during investor withdrawals and de-levered during contributions.  We provide a general equation to describe the relationship and recommend the use of short dated currency forwards to hedge the risk.

Authors: Matthew Lyberg, CFA, CIPM Acadian Asset Management and Alexander Dunegan, State Street Global Investors

Kawaller (1992) demonstrates the financial risk when there is a difference between the settlement dates of an international asset trade and the currency required for or generated from the asset trade.  We extend Kawaller's work to equity portfolios with investor flows, finding that the foreign exchange risk becomes levered during investor withdrawals and de-levered during contributions.  We provide a general equation to describe the relationship and recommend the use of short dated currency forwards to hedge the risk.

 

Flows and Woes: The True Costs of Spot Trading Policy.

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