A Presentation on Hedging as Exchange Risk Offsetting Tool

Presentation Transcript

A Presentation on Hedging as Exchange Risk Offsetting Tool Presented by AKM Abdullah October 26, 2004

This Session Covers What is Hedging Types of Hedging Examples Comparison of Different Hedging Techniques

Defining Hedge Hedge alludes to a counterbalancing contract made so as to protect the home cash estimation of receivables or payables designated in outside coin. Target of supporting is to o ffset trade chance emerging from exchange introduction.

Types of Hedging 1. Forward Market Hedges: use forward contracts to counterbalance swapping scale introduction 2. Currency Market Hedges: utilize getting and loaning in the currency markets 3. Supporting with Swaps: utilize blend of forward and currency advertise instruments 4. Supporting with Foreign Currency Futures: 5. Supporting with Foreign Currency Options:

Forward Market Hedges: Objective : To invalidate future spot rate 2 Situations: Expected Inflows of Foreign Currency: Make forward contracts to offer the remote cash at a predetermined rate to protect against devaluation of estimation of that outside coin (as far as home money). 2. Expected Outflows of Foreign Currency: Make forward contracts to purchase the remote money at a predefined rate to protect against valuation for estimation of the coin (as far as home cash).

Examples 1. A US firm is relied upon to get 200,000 UK pound in 60 days from a UK purchaser. UK pound may devalue against US $ in 60 days. What to Do for counterbalancing the danger of accepting less measure of US $? 2. A US firm will need to pay 400,000 Euros in 30 days to a German vender. Euro may acknowledge against US $ in 30 days. What to accomplish for counterbalancing the danger of spending more US $?

Money Market Hedges Objective: obtain/loan to secure home coin estimation of income 1. Expected Inflow of Foreign Currency: Borrow show estimation of the remote coin at an altered premium and change over it into home cash Deposit the home money at a settled financing cost When the outside coin is gotten, utilize it to pay off the remote cash credit

Money Market Hedges (Continued) 2. Expected Outflow of Foreign Currency: Determine PV of the outside money to be paid (utilizing remote cash financing cost as the markdown rate). Acquire proportionate measure of home money (considering spot swapping scale) Convert the home cash into PV likeness the remote coin (in the spot showcase now) and make an outside coin store On installment day, pull back the remote coin store (which when levels with the payable sum) and make installment.

Example A US firm is relied upon to pay A$300,000 to an Australian provider 3 months from now. A$ loan fee is 12% and US$ financing cost 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 change over it to A$291,262.14 at spot rate (0.60/US$) Use the A$ to make an A$ store which will develop to A$300,000 in 3 months. Pay this A$300,000 on due date Pay {174,757.28X(1+0.8/4)} US$178,252.43 with enthusiasm for settling the US$ advance.

Money Market Hedge Conditions for Use Firms have admittance to currency showcase for various monetary forms The dates of expected future money streams and currency advertise exchange development coordinate Offshore cash stores or Eurocurrency stores are primary currency showcase fence instruments

Comparison: Forward and Money Market Hedge The secured premium equality suggests that a firm can't be in an ideal situation utilizing currency advertise support contrasted with forward support. In actuality, firms discover utilization of forward contracts more gainful than utilization of currency market instruments; since firms: Borrow at a rate> between bank seaward loaning rate Put stores at a rate< between bank seaward store rate.

Hedge utilizing Swaps Swap alludes to trade of a concurred measure of a cash for another money at a particular future date. This is identical to cash forward contract adroitly. For instance: a US firm has receivable in Euro from a Belgian purchaser; so it is searching for euro designated risk to support the receivable. Then again, a Belgian firm fares to USA and has US$ named receivable; it needs US$ risk to support receivables in US$. The two firms can concur that:

Swaps (Continued) US firm obtains (say $100,000) at 11% Belgian firm borrows($100,000/E0.6 per $) 166,667 euros at 10% US firm gets euros from purchaser and offer it to the Belgian firm so that it (Belgian) can reimburse euro named advance. The Belgian firm gets US$ from purchaser and offer it to the US firm so that it (US firm) can reimburse US$ designated advance. Both firms secure current spot rate for future installments by swapping receivables.

Questions? Have a Great Day