Question

Greeley Co., a U.S.firm, has a payable in Polish zloty due in 90 days. The firm is worried that the zloty may appreciate against the U.S.dollar so that the payable in dollars would go up. The company would like to hedge this transaction exposure. Since forward contracts and other hedging techniques are not possible for the zloty, Greeley is considering cross-hedging. Which of the following major currencies is the most effective for cross-hedging purpose?

a. The euro, which has a correlation of 0.91 with the zloty.

b. The Swiss franc, which has a correlation of 0.76 with the zloty.

c. The Japanese yen, which has a correlation of 0.53 with the zloty.

d. The Australian dollar, which has a correlation of 0.26 with the zloty.

Answer 1

Correlation coefficient represents degree of relation between two securities

The value of correlation coefficient ranges from -1 to +1

Higher the correlation coefficient, the value of both securities move in the same direction

Hence, for hedging, the currency with highest correlation with Zloty will be preferred as the value os this currency will change in the same manner as zloty.

Hence, the answer is   

a. The euro, which has a correlation of 0.91 with the zloty.