How a currency move becomes a margin call
If your collateral is denominated in dollars and your facility is drawn in euros, a strengthening euro raises the euro value of your debt while the euro value of your collateral is unchanged in dollar terms. The loan-to-value rises even though every holding in your portfolio is flat.
Lenders anticipate this by applying a currency haircut, typically 5%–15%, which reduces your advance rate before you draw a single euro.
Three ways to manage the mismatch
- Borrow in the currency of the investment and hold sufficient collateral in that currency where possible
- Hedge the exposure with forwards, at a cost of roughly 0.2%–0.8% per year depending on the pair
- Part-fund in cash so the financed portion, and therefore the mismatch, is smaller
The cost of hedging versus the cost of not hedging
Hedging looks expensive until you model the alternative. A 10% adverse move on a €500,000 facility is €50,000 of additional effective debt, arriving at the moment your headroom is most valuable.
For positions committed for five to ten years, a modest annual hedging cost usually buys more certainty than it destroys in return.
Stress test currency and equity shocks together. Assuming they are independent understates the tail risk of a leveraged cross-currency position.
Frequently asked questions
Should I always borrow in the investment currency?+
Where your collateral supports it, yes. It removes the mismatch entirely and avoids the lender's currency haircut on your advance rate.
What does hedging cost?+
Typically 0.2%–0.8% per year depending on the currency pair and interest rate differential.
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