Hedging As Exchange Risk Offsetting Tool: A Presentation On

A Presentation on
Hedging as Exchange Risk Offsetting Tool

Presented by
Satish Verma
This Session Covers

What is Hedging Types of Hedging Examples Comparison of Different Hedging Techniques
10/26/2004
Defining Hedge
Hedge refers to an offsetting contract made in order to insulate the home currency value of receivables or payables denominated in foreign currency. Objective of hedging is to offset exchange
risk arising from transaction exposure.
10/26/2004 3
Types of Hedging
1. Forward Market Hedges: use forward
contracts to offset exchange rate exposure
2. Money Market Hedges: use borrowing and

lending in the money markets
3. Hedging with Swaps: use combination of

forward and money market instruments 4. Hedging with Foreign Currency Futures: 5. Hedging with Foreign Currency Options:
10/26/2004
Forward Market Hedges: Objective: To nullify future spot rate

2 Situations: 1. Expected Inflows of Foreign Currency:
Make forward contracts to sell the foreign currency at a specified rate to insulate against depreciation of value of that foreign currency (in terms of home currency).
2. Expected Outflows of Foreign Currency:

Make forward contracts to buy the foreign currency at a specified rate to insulate against appreciation of value of the currency (in terms of home currency).
10/26/2004 5
Examples
1. A US firm is expected to receive 200,000
UK pound in 60 days from a UK buyer. UK pound may depreciate against US $ in 60 days.

What to Do for offsetting the risk of receiving less amount of US $?
2. A US firm will have to pay 400,000 Euros
in 30 days to a German seller. Euro may appreciate against US $ in 30 days.

What to do for offsetting the risk of spending more US $?
10/26/2004 6
Money Market Hedges

Objective: borrow/lend to lock in home currency value of cash flow
1. Expected Inflow of Foreign Currency:

Borrow present value of the foreign currency at a
fixed interest and convert it into home currency Deposit the home currency at a fixed interest rate When the foreign currency is received, use it to pay off the foreign currency loan
10/26/2004
Money Market Hedges

(Continued)
2. Expected Outflow of Foreign Currency:

Determine PV of the foreign currency to be paid (using foreign currency interest rate as the discount rate). Borrow equivalent amount of home currency (considering spot exchange rate) Convert the home currency into PV equivalent of the foreign currency (in the spot market now) and make a foreign currency deposit On payment day, withdraw the foreign currency deposit (which by the time equals the payable amount) and make payment.
10/26/2004 8
Example
A US firm is expected to pay A$300,000 to an Australian supplier 3 months from now. A$ interest rate is 12% and US$ interest rate is 8%. Spot rate is 0.60A$/US$.
PV of A$: 300,000/(1+.12/4) = A$291,262.14 Borrow (291,262.14X0.60) US$174,757.28 and convert it to A$291,262.14 at spot rate (0.60/US$) Use the A$ to make an A$ deposit which will grow to A$300,000 in 3 months. Pay this A$300,000 on due date Pay {174,757.28X(1+0.8/4)} US$178,252.43 with interest for settling the US$ loan.
10/26/2004 9
Money Market Hedge

Conditions for Use
Firms have access to money market for different currencies The dates of expected future cash flows and money market transaction maturity match Offshore currency deposits or Eurocurrency deposits are main money market hedge instruments
10/26/2004 10
Comparison: Forward and Money Market Hedge

The covered interest parity implies that a firm cannot be better off using money market hedge compared to forward hedge. In reality, firms find use of forward contracts more profitable than use of money market instruments; because firms:
A) Borrow at a rate> inter-bank offshore lending rate B) Put deposits at a rate< inter-bank offshore deposit rate.
10/26/2004 11
Hedge using Swaps

Swap refers to exchange of an agreed amount of a currency for another currency at a specific future date. This is equivalent to currency forward contract in a sophisticated way.
For example: a US firm has receivable in Euro from a Belgian buyer; so it is looking for euro denominated liability to hedge the receivable. On the other hand, a Belgian firm exports to USA and has US$ denominated receivable; it needs US$ liability to hedge receivables in US$.
The two firms can agree that:

10/26/2004 12
Swaps (Continued)
US firm borrows (say $100,000) at 11% Belgian firm borrows($100,000/E0.6 per $) 166,667 euros at 10% US firm receives euros from buyer and give it to the Belgian firm so that it (Belgian) can repay euro denominated loan. The Belgian firm receives US$ from buyer and give it to the US firm so that it (US firm) can repay US$ denominated loan. Both firms lock in current spot rate for future payments by swapping receivables.
10/26/2004 13
Questions?
Have a Great Day

10/26/2004 14

Hedging As Exchange Risk Offsetting Tool: A Presentation On

Uploaded by

Copyright:

Available Formats

Hedging As Exchange Risk Offsetting Tool: A Presentation On

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Hedging As Exchange Risk Offsetting Tool: A Presentation On

Uploaded by

Copyright:

Available Formats

A Presentation on

Hedging as Exchange Risk Offsetting Tool

This Session Covers

2. Money Market Hedges: use borrowing and

3. Hedging with Swaps: use combination of

Forward Market Hedges: Objective: To nullify future spot rate

2. Expected Outflows of Foreign Currency:

UK pound in 60 days from a UK buyer. UK pound may depreciate against US $ in 60 days.

2. A US firm will have to pay 400,000 Euros

in 30 days to a German seller. Euro may appreciate against US $ in 30 days.

Money Market Hedges

1. Expected Inflow of Foreign Currency:

Money Market Hedges

2. Expected Outflow of Foreign Currency:

Money Market Hedge

Comparison: Forward and Money Market Hedge

Hedge using Swaps

The two firms can agree that:

Have a Great Day

You might also like

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.