2
$\begingroup$

https://www.bis.org/publ/qtrpdf/r_qt1709e.pdf

extract from page 38

An investor wants to buy a foreign currency security with domestic cash but does not wish to run FX risk. Then, three transactions are equivalent. The agent may:

  1. combine a spot and forward FX deal, ie buy the required FX spot, purchase the security and sell the same amount of FX forward;
  2. use an FX swap, ie swap the domestic currency for the foreign currency and purchase the security;
  3. keep the domestic cash and finance the security by borrowing in the foreign repo market, incurring outright debt.

I am a little confused about strategy 3, does it mean you lend your local ccy cash in exchange for the foreign security or something else?

$\endgroup$

1 Answer 1

3
$\begingroup$

It means: purchase the foreign asset and simultaneously use this asset as collateral to borrow money in the same currency. For example, you are a USD investor. You buy a Japanese Government bond for Yen 1bn, and you enter a repo where you borrow Yen 1bn by pledging the JGB as collateral. By doing this, you have no FX risk.

$\endgroup$
8
  • $\begingroup$ step by step, do you mean this? 1) US investor exchanges USD for JPY at spot rate 2) uses the yen amount to buy a JGB 3) pledges JGB as collateral and get yen from the repo counterparty 4) at maturity of repo returns yen in exchange for the JGB 5) sells JGB and converts yen back into USD $\endgroup$
    – Student
    Dec 26, 2020 at 18:20
  • $\begingroup$ Yes except there is no need to do any spot FX transactions. The exact steps depend on what clearing houses and settlement mechanisms are in place. Crucial to understand there are no FX transactions. $\endgroup$
    – dm63
    Dec 27, 2020 at 1:59
  • $\begingroup$ For example you can purchase JGB and initiate repo for the Same settlement date, so the Yen flows net out. $\endgroup$
    – dm63
    Dec 27, 2020 at 2:01
  • $\begingroup$ Ok it would be interesting to know how you can buy a foreign asset without fx transactions in this case. Also because in a repo you usually borrow cash by pledging assets: en.wikipedia.org/wiki/Repurchas $\endgroup$
    – Student
    Dec 27, 2020 at 9:28
  • $\begingroup$ "For example you can purchase JGB and initiate repo for the Same settlement date, so the Yen flows net out", why would they net out? $\endgroup$
    – Student
    Dec 27, 2020 at 9:30

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge that you have read and understand our privacy policy and code of conduct.

Not the answer you're looking for? Browse other questions tagged or ask your own question.