Unlike selling short a stock, an investor can contract to sell a currency at a future date without using any leverage. This is because you don’t need to physically borrow a stock off another investor with the intention of paying for it at some future point in time. Rather, through a forward currency contract, an investor can enter into an agreement to sell a currency for a predetermined price on a specified future date.
By contracting to sell one currency, an investor is, by implication, also contracting to purchase another currency, as currencies always trade in pairs. By way of example, if an investor entered into a contract to purchase Australian dollars (AUD) by selling U.S. dollars (USD), this transaction in itself would create a net short USD position and a net long AUD position. Conversely, if the fund were to enter into a contract to purchase USD by selling AUD, this transaction itself would create a net long USD position and a net short AUD position.
Forward currency contracts require no initial outlay and the counterparty exposure is confined to the profit or loss on the contract. Both the Merk Absolute Return and Merk Asian Currency Funds may gain currency exposure through the use of forward currency contracts; the net notional U.S. dollar value of these contracts is typically fully collateralized.
To keep informed, and be updated when we post another Currencies Uplugged, please subscribe to our newsletter, Merk Insights.