The overlay manager uses forward contracts to match the portfolio’s currency exposures in such a way as to insure against exchange rate fluctuations.
The most common categories in active currency overlay are as follows:[2] Fundamental managers believe they can exploit price inefficiencies using models and processes in which economic and financial data are used as the ‘exogenous’ variables, including balance of payments, capital flows, price levels, monetary conditions, etc.
Dynamic managers are a group that aims to create an asymmetric return—running profits and cutting losses—with forwards or option technology.
Because the market is dominated by highly constrained participants like industrial and commercial companies, fund managers, portfolio investors, and central banks, there still exist arbitrage opportunities that are not fully exploited.
These include cyclical behaviour, trending, disparities in implied and actual volatility, and the forward rate bias.