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A Presentation on

A Presentation on
Hedging as Exchange Risk
Hedging as Exchange Risk
Offsetting Tool
Offsetting Tool
Presented by Presented by
AKM Abdullah
AKM Abdullah
October 26 2!!" October 26 2!!"
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This %ession &o'ers
This %ession &o'ers
(hat is Hedging
(hat is Hedging
Ty)es of Hedging
Ty)es of Hedging
Exa*)les
Exa*)les
&o*)arison of +ifferent Hedging
&o*)arison of +ifferent Hedging
Techni,ues
Techni,ues
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+efining Hedge
+efining Hedge
Hedge refers to an offsetting contract
Hedge refers to an offsetting contract
*ade in order to insulate the ho*e
*ade in order to insulate the ho*e
currency 'alue of recei'ables or )ayables
currency 'alue of recei'ables or )ayables
deno*inated in foreign currency.
deno*inated in foreign currency.


Ob/ecti'e of hedging is to o
Ob/ecti'e of hedging is to o
ffset exchange
ffset exchange
risk arising fro* transaction ex)osure.
risk arising fro* transaction ex)osure.
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Ty)es of Hedging
Ty)es of Hedging
#. 0or1ard Market Hedges2
#. 0or1ard Market Hedges2
use for1ard
use for1ard
contracts to offset exchange rate ex)osure
contracts to offset exchange rate ex)osure
2. Money Market Hedges2
2. Money Market Hedges2
use borro1ing and
use borro1ing and
lending in the *oney *arkets
lending in the *oney *arkets
-. Hedging 1ith %1a)s2
-. Hedging 1ith %1a)s2
use co*bination of
use co*bination of
for1ard and *oney *arket instru*ents
for1ard and *oney *arket instru*ents
". Hedging 1ith 0oreign &urrency 0utures2
". Hedging 1ith 0oreign &urrency 0utures2
3. Hedging 1ith 0oreign &urrency O)tions2
3. Hedging 1ith 0oreign &urrency O)tions2
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0or1ard Market Hedges2
0or1ard Market Hedges2
Ob/ecti'e
Ob/ecti'e
2
2
To nullify future s)ot rate
To nullify future s)ot rate
2 %ituations2
2 %ituations2
#.
#.
Ex)ected 4nflo1s of 0oreign &urrency2
Ex)ected 4nflo1s of 0oreign &urrency2
Make for1ard contracts to sell the foreign currency at Make for1ard contracts to sell the foreign currency at
a s)ecified rate to insulate against de)reciation of a s)ecified rate to insulate against de)reciation of
'alue of that foreign currency 5in ter*s of ho*e 'alue of that foreign currency 5in ter*s of ho*e
currency6. currency6.
2. Ex)ected Outflo1s of 0oreign &urrency2
2. Ex)ected Outflo1s of 0oreign &urrency2
Make for1ard contracts to buy the foreign currency at Make for1ard contracts to buy the foreign currency at
a s)ecified rate to insulate against a))reciation of a s)ecified rate to insulate against a))reciation of
'alue of the currency 5in ter*s of ho*e currency6. 'alue of the currency 5in ter*s of ho*e currency6.
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Exa*)les
Exa*)les
#.
#.
A 7% fir* is ex)ected to recei'e 2!!!!!
A 7% fir* is ex)ected to recei'e 2!!!!!
7K )ound in 6! days fro* a 7K buyer. 7K
7K )ound in 6! days fro* a 7K buyer. 7K
)ound *ay de)reciate against 7% 8 in 6!
)ound *ay de)reciate against 7% 8 in 6!
days.
days.
(hat to +o for offsetting the risk of recei'ing less (hat to +o for offsetting the risk of recei'ing less
a*ount of 7% 89 a*ount of 7% 89
2.
2. A 7% fir* 1ill ha'e to )ay "!!!!! Euros
A 7% fir* 1ill ha'e to )ay "!!!!! Euros
in -! days to a :er*an seller. Euro *ay
in -! days to a :er*an seller. Euro *ay
a))reciate against 7% 8 in -! days.
a))reciate against 7% 8 in -! days.
(hat to do for offsetting the risk of s)ending *ore 7% 89 (hat to do for offsetting the risk of s)ending *ore 7% 89
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Money Market Hedges
Money Market Hedges
Ob/ecti'e2 borro1$lend to lock in ho*e
Ob/ecti'e2 borro1$lend to lock in ho*e
currency 'alue of cash flo1
currency 'alue of cash flo1
#. Ex)ected 4nflo1 of 0oreign &urrency2
#. Ex)ected 4nflo1 of 0oreign &urrency2

<orro1 )resent 'alue of the foreign currency at a <orro1 )resent 'alue of the foreign currency at a
fixed interest and con'ert it into ho*e currency fixed interest and con'ert it into ho*e currency

+e)osit the ho*e currency at a fixed interest rate +e)osit the ho*e currency at a fixed interest rate

(hen the foreign currency is recei'ed use it to (hen the foreign currency is recei'ed use it to
)ay off the foreign currency loan )ay off the foreign currency loan
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Money Market Hedges
Money Market Hedges
5&ontinued6 5&ontinued6
2. Ex)ected Outflo1 of 0oreign &urrency2
2. Ex)ected Outflo1 of 0oreign &urrency2
>
+eter*ine P? of the foreign currency to be )aid +eter*ine P? of the foreign currency to be )aid
5using foreign currency interest rate as the discount rate6. 5using foreign currency interest rate as the discount rate6.
>
<orro1 e,ui'alent a*ount of ho*e currency 5considering <orro1 e,ui'alent a*ount of ho*e currency 5considering
s)ot exchange rate6 s)ot exchange rate6
>
&on'ert the ho*e currency into P? e,ui'alent of the &on'ert the ho*e currency into P? e,ui'alent of the
foreign currency 5in the s)ot *arket no16 and *ake a foreign currency 5in the s)ot *arket no16 and *ake a
foreign currency de)osit foreign currency de)osit
>
On )ay*ent day 1ithdra1 the foreign currency de)osit On )ay*ent day 1ithdra1 the foreign currency de)osit
51hich by the ti*e e,uals the )ayable a*ount6 and *ake 51hich by the ti*e e,uals the )ayable a*ount6 and *ake
)ay*ent. )ay*ent.
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Exa*)le
Exa*)le
A 7% fir* is ex)ected to )ay A8-!!!!! to an
A 7% fir* is ex)ected to )ay A8-!!!!! to an
Australian su))lier - *onths fro* no1. A8
Australian su))lier - *onths fro* no1. A8
interest rate is #2A and 7%8 interest rate is =A.
interest rate is #2A and 7%8 interest rate is =A.
%)ot rate is
%)ot rate is
!.6!A8$7%8.
!.6!A8$7%8.
>
P? of A82 -!!!!!$5#B.#2$"6 C P? of A82 -!!!!!$5#B.#2$"6 C A82@#262.#" A82@#262.#"
>
<orro1 52@#262.#"D!.6!6 <orro1 52@#262.#"D!.6!6 7%8#;";3;.2= 7%8#;";3;.2= and con'ert it to and con'ert it to
A82@#262.#" at s)ot rate 5!.6!$7%86 A82@#262.#" at s)ot rate 5!.6!$7%86
>
7se the A8 to *ake an A8 de)osit 1hich 1ill gro1 to 7se the A8 to *ake an A8 de)osit 1hich 1ill gro1 to
A8-!!!!! A8-!!!!! in - *onths. Pay this A8-!!!!! on in - *onths. Pay this A8-!!!!! on due date due date
>
Pay E#;";3;.2=D5#B!.=$"6F 7%8#;=232."- 1ith interest for Pay E#;";3;.2=D5#B!.=$"6F 7%8#;=232."- 1ith interest for
settling the 7%8 loan. settling the 7%8 loan.
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Money Market Hedge
Money Market Hedge
&onditions for 7se
&onditions for 7se
0ir*s ha'e access to *oney *arket for
0ir*s ha'e access to *oney *arket for
different currencies
different currencies
The dates of ex)ected future cash flo1s
The dates of ex)ected future cash flo1s
and *oney *arket transaction *aturity
and *oney *arket transaction *aturity
*atch
*atch
Offshore currency de)osits or Eurocurrency
Offshore currency de)osits or Eurocurrency

de)osits are *ain *oney *arket hedge
de)osits are *ain *oney *arket hedge
instru*ents
instru*ents
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&o*)arison2
&o*)arison2
0or1ard and Money Market Hedge
0or1ard and Money Market Hedge
The co'ered interest )arity i*)lies that a fir*
The co'ered interest )arity i*)lies that a fir*
cannot be better off using *oney *arket
cannot be better off using *oney *arket
hedge co*)ared to for1ard hedge.
hedge co*)ared to for1ard hedge.
4n reality fir*s find use of for1ard contracts
4n reality fir*s find use of for1ard contracts
*ore )rofitable than use of *oney *arket
*ore )rofitable than use of *oney *arket
instru*entsG because fir*s2
instru*entsG because fir*s2
A6 A6 <orro1 at a rateH interIbank offshore lending rate <orro1 at a rateH interIbank offshore lending rate
<6 <6 Put de)osits at a rateJ interIbank offshore de)osit Put de)osits at a rateJ interIbank offshore de)osit
rate. rate.
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Hedge using %1a)s
Hedge using %1a)s
%1a) refers to exchange of an agreed a*ount of a
%1a) refers to exchange of an agreed a*ount of a
currency for another currency at a s)ecific future
currency for another currency at a s)ecific future
date. This is e,ui'alent to currency for1ard contract
date. This is e,ui'alent to currency for1ard contract
in a so)histicated 1ay.
in a so)histicated 1ay.
0or exa*)le2 a 7% fir* has recei'able in Euro fro* a
0or exa*)le2 a 7% fir* has recei'able in Euro fro* a
<elgian buyerG
<elgian buyerG
so it is looking for euro deno*inated liability so it is looking for euro deno*inated liability
to hedge the recei'able. to hedge the recei'able.
On the other hand a <elgian fir* ex)orts to 7%A and has On the other hand a <elgian fir* ex)orts to 7%A and has
7%8 deno*inated recei'ableG 7%8 deno*inated recei'ableG it needs 7%8 liability to hedge it needs 7%8 liability to hedge
recei'ables in 7%8. recei'ables in 7%8.
The t1o fir*s can agree that2
The t1o fir*s can agree that2
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%1a)s
%1a)s 5&ontinued6 5&ontinued6
7% fir* borro1s 5say 8#!!!!!6 at ##A
7% fir* borro1s 5say 8#!!!!!6 at ##A
<elgian fir* borro1s58#!!!!!$E!.6 )er 86
<elgian fir* borro1s58#!!!!!$E!.6 )er 86
#6666; euros at #!A
#6666; euros at #!A
7% fir* recei'es euros fro* buyer and gi'e it to
7% fir* recei'es euros fro* buyer and gi'e it to
the <elgian fir* so that it 5<elgian6 can re)ay
the <elgian fir* so that it 5<elgian6 can re)ay
euro deno*inated loan.
euro deno*inated loan.
The <elgian fir* recei'es 7%8 fro* buyer and
The <elgian fir* recei'es 7%8 fro* buyer and
gi'e it to the 7% fir* so that it 57% fir*6 can
gi'e it to the 7% fir* so that it 57% fir*6 can
re)ay 7%8 deno*inated loan.
re)ay 7%8 deno*inated loan.
>
<oth fir*s lock in current s)ot rate for future
<oth fir*s lock in current s)ot rate for future
)ay*ents by s1a))ing recei'ables.
)ay*ents by s1a))ing recei'ables.
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Kuestions9
Kuestions9
Ha'e a :reat +ay
Ha'e a :reat +ay