Question

You are a manager of a hedge fund that has a trading strategy based on picking which currencies you believe will change in value in a significant way in a short period of time. If you believe that the value of the British pound will appreciate in the near future against the euro, you will

1) buy euros
2) sell euros
3) buy British pounds, and possibly sell euros
4) sell British pounds, and buy euros with dollars

Answer 1

To capitalize on the anticipated appreciation of the British pound against the euro, you should buy British pounds and possibly sell euros. Hedging is a strategy to protect against the risk of exchange rate fluctuations.

Step-by-step explanation:

If you believe that the value of the British pound will appreciate against the euro, the correct action is to buy British pounds, and possibly sell euros. This trading strategy is based on the expectation that the British pound will increase in value, and by purchasing pounds now, you can benefit from this potential appreciation. Conversely, if you currently hold euros and expect their value to decrease in comparison to the British pound, selling euros would prevent potential losses from this expected depreciation.

Hedging is a common portfolio investment decision where financial transactions are used to protect against the risk of exchange rate movements. For example, a U.S. firm exporting to France and receiving payment in euros may use hedging to lock in the current exchange rate, avoiding the risk of the euro depreciating against the U.S. dollar.

By holding British pounds, you can then exchange them back for euros at a later time when the exchange rate is more favorable. This strategy allows you to capitalize on your prediction of the currency market.