Hedging against currency risk

Question

Is there a hedging method against currency risk without lowering returns ? Classic hedging methods like forwards, futures options, all have a cost and don’t remove risk “for free”.

Answer 1

In a word: "no". Essentially, the old adage:

You don't get something for nothing.

applies.

If there was a way of removing risk for free (i.e. without lowering returns), then that element of risk essentially wouldn't be there in the first place (there'd be no reason not to remove it all the time).

If it costs something (in lowered returns) to remove (some of) the risk, you have the normal trade-off between high-risk (= higher gains; deeper losses) or lower risk (= more modest gains; lower losses).

Answer 2

Options have cost, true, because you can limit the downside while keeping upside potential.

However, forwards and futures just have transaction costs, which are usually minimal. The only "cost" is that you lock in a exchange rate, so you lose both upside and downside potential, and the rate you can lock in may be worse than the rate you get now.

So FX futures could be used to reduce currency risk with little to no cost. Whether you can perfectly hedge risk depends on the size of your risk (exchange contracts are usually on the order of thousands of dollars) and the timing of future transactions (exchange delivery only happens once per month)