Why there is no need for currency hedging in cash-neutral trade. The spread you earn on the steepest curve of foreign currency needs to be converted back to domestic currency.
Please explain.
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I assume you’re asking this question in a cash neutral & duration neutral reference.
In this scenario, no currency hedging required as you have long short exposure in both the currencies such that duration is hedged and cash itself is neutralized.
Let me explain with an example. Let’s say UK yield curve is very steep compared to US yield curve and we want to take a cash neutral & duration neutral trade to enjoy the carry.
So, in this what we do is to enjoy UK yield steeper curve , we short 2s10 (for example) i.e. short 2y and long 10y UK gilts because UK curve is steep and so long end i.e. 10y yield is attractive here. And US yield curve is flat , so we long 2s10 here i.e. long 2y & short 10y.
In this trade, our overall duration is hedged and currency is also neutral here.
Thanks for the explanation. I understood this part but I am thinking about the Pound yield earned on UK Gilts. We ought to convert the yield earned in pound into US dollars, oughtn’t we?