  We develop an optimal currency hedging strategy for fund managers who own
foreign assets to choose the hedge tenors that maximize their FX carry returns
within a liquidity risk constraint. The strategy assumes that the offshore
assets are fully hedged with FX forwards. The chosen liquidity risk metric is
Cash Flow at Risk (CFaR). The strategy involves time-dispersing the total
nominal hedge value into future time buckets to maximize (minimize) the
expected FX carry benefit (cost), given the constraint that the CFaRs in all
the future time buckets do not breach a predetermined liquidity budget. We
demonstrate the methodology via an illustrative example where shorter-dated
forwards are assumed to deliver higher carry trade returns (motivated by the
historical experience where AUD is the domestic currency and USD is the foreign
currency). We also introduce a tenor-ranking method which is useful when this
assumption fails. We show by Monte Carlo simulation and by backtesting that our
hedging strategy successfully operates within the liquidity budget. We provide
practical insights on when and why fund managers should choose short-dated or
long-dated tenors.
