A portfolio model for foreign exchange exposure management

Abstract

This paper summarizes the results of our research into applications of decision analysis and portfolio theory to the management of foreign exchange exposure. In contrast with much current practice in foreign exchange management, the portfolio approach takes into explicit consideration the inherent relationships among the currencies in the company's foreign currency portfolio. The hedging model developed in this article traces out an 'efficient frontier' or trade-off curve between expected value and variance of the foreign currency portfolio at the end of the planning period. In doing so, the model chooses the optimal amount and method of hedging for each currency in the portfolio.