Currency Overlay: A Practical Guide

Posted by Allison on 13 April 2009, 10:57

The practice of currency overlay is generally practiced by extremely large banks and corporations, but understanding what it is and why it is important are good things for all foreign currency exchange market traders to understand.  Currency Overlay:  A Practical Guide is a very good book for this purpose, offering clear and concise explanations to help the reader truly comprehend the practice of currency overlay.     

What is currency overlay and why is it important?

The practice of currency overlay is important to large banks and corporations because it allows them to better manage the currency risk that is in their existing portfolios.  How?  By turning over the management of currency risk to an outside provider rather than continuing to manage it within the organisation itself.   Currency Overlay:  A Practical Guide emphasises that the practice of currency overlay is reserved for existing currency risk in an existing international portfolio, not for taking on new currency risk and then managing it. 

As explained in Currency Overlay:  A Practical Guide, a corporation or bank with currency risk exposure has three options for how to handle the risk:

Currency Overlay:  A Practical Guide covers all of this in excellent detail, explaining that currency overlay is one of the most popular methods chosen by large institutions.

Two approaches to currency overlay management

There are two primary approaches to currency overlay management:

The approach used by the currency overlay management firm depends on the needs and requirements of the institution that has hired their services.  Some clients, such as some pension funds and retirement agencies, are typically interested in the hedging approach as a way to reduce risk and ensure the continued stability and growth of their portfolio.  Other clients, such as some corporations and large banks, prefer the speculative approach because it allows them to more aggressively go after larger, more profitable returns.

Currency Overlay:  A Practical Guide contains excellent discussions of these approaches, including specific detail that really makes them become clear.  Even with this level of detail, however, the book does not lose any of its readability at all.

Comprehensive collection of currency overlay topics

One the reasons why Currency Overlay:  A Practical Guide is such an excellent resource is the comprehensive collection of topics it includes, providing very clear and thorough explanations of all aspects related to currency overlay.

Let's take a look at just a few of these topics:

How do currency managers reduce risk and still generate profits?

This is a common question related to currency overlay practices, and one that Currency Overlay:  A Practical Guide discusses quite thoroughly.  The discussion centres on why the opportunities exist and which currency market participants typically influence the quantity and scope of these opportunities:

All of these participants create opportunities for currency overlay managers to achieve profitable trades while still maintaining a reasonable level of currency risk management.

Final thoughts

While currency overlay is not a topic or practice individual investors need to concern themselves with directly, all traders should have a good understanding of what it is and how it works because it can influence their trading activities indirectly.  There are many books available on this subject, but few are as accessible and as easy to understand as Currency Overlay:  A Practical Guide.

This book is full of information and explanations that make the concept of currency overlay very clear, but without getting too deeply into the nuances and complexities of it.  There are numerous graphs and illustrations to go along with each topic, making it particularly easy to visualize the concepts discussed.  The author does an excellent job of presenting a combination of specific details along with supporting visuals, helping the reader understand the concept being presented more quickly.

In general, Currency Overlay:  A Practical Guide is the kind of book every foreign currency exchange market trader should consider adding to their resource library.  While it is not a book that will be used every day or on a regular basis, it is something that provides additional information about the currency markets that is well worth reading about and understanding.

Direct link to this book at Amazon

 

Comment

  1. I must admit this whole currency overlay thing really went over my head. I read the whole article and I’m not much the wiser. I’ll have to read it again I think. Although having said that the book seems like a good bet if anyone wants to find out more about it. It doesn’t seem to be something that impinges on many people’s consciousness – I have certainly never heard of it before and I bet I’m not alone in saying that.

    — Jen · Mar 30, 09:08 AM · #