Worked Example For External Hedging Techniques In Dealing With Transaction Exposures
Hogan Plc.
Discussion
You have receivables of AUD 28 million (to be paid in 3 months)
You need to identify the most appropriate strategy to be used in hedging the transaction exposures.
Choose between:
i. Forward market hedge ii. Money market hedge iii. Options hedging
Strategy 1: hedging using forward contract
Because Hogan will receive AUD in 6-months, their concern is that they’ll have to convert the AUD to less USD.
1) Today, Hogan buys a forward contract to sell AUD (they’ll receive in 6 months) at locked forward rate of AUD 2.805/£
2) At t=6, Hogan will receive AUD 28 million
3) Hogan sells this AUD28 million at AUD 2.805/£ and get £9.98 million in return
Hogan’s profit under the following spot rates will be:
a) If spot rate at t=6 : AUD 2.78/£
Example:
Profit/loss = £ proceeds from forward contract - £ proceeds from doing nothing = (
b) If spot rate at t=6: AUD 2.82/£
Profit/loss =0.05 mill
Strategy 2: Hedging using money market hedge
Money market hedge is a strategy used where exporter creates a liability in the form of short term loans in the same currency it expects to receive
In AUSTRALIA, the interest rate =
In UK, the interest rate =
1) Hogan will borrow _______ AUD to accumulate at 2.25% to the AUD value of its receipts.
Amount to borrow today : AUD28mill/(1+0.0225) =AUD 27.38 mill
2) Exchange this AUD27.38mill loaned amount into £ at today’s spot rate to receive: = £ 9.78 mill
3) Invest £9.78 mill at 1% in UK to accumulate £9.78 mill x (1+0.01) =£ 9.88 mill
Hogan’s profit under the following spot rates at t=3 will be:
a) If AUD 2.78/£
Profit/loss = £ 9.88 million - £10.07 million = -£ 0.19 million
b) If AUD 2.82/£
Profit/loss = -£0.05 million
Strategy 3: Using option hedging
Given in information number 3:
American put option
Gives the right to sell AUD at AUD 2.81/£
Premium = £ 200,000 (i.e. £0.2 million)
Hogan’s profit under the following spot rates at t=3 will be:
a) When AUD 2.78/£
If Hogan do nothing (i.e. sell AUD at
Discussion
You have receivables of AUD 28 million (to be paid in 3 months)
You need to identify the most appropriate strategy to be used in hedging the transaction exposures.
Choose between:
i. Forward market hedge ii. Money market hedge iii. Options hedging
Strategy 1: hedging using forward contract
Because Hogan will receive AUD in 6-months, their concern is that they’ll have to convert the AUD to less USD.
1) Today, Hogan buys a forward contract to sell AUD (they’ll receive in 6 months) at locked forward rate of AUD 2.805/£
2) At t=6, Hogan will receive AUD 28 million
3) Hogan sells this AUD28 million at AUD 2.805/£ and get £9.98 million in return
Hogan’s profit under the following spot rates will be:
a) If spot rate at t=6 : AUD 2.78/£
Example:
Profit/loss = £ proceeds from forward contract - £ proceeds from doing nothing = (
b) If spot rate at t=6: AUD 2.82/£
Profit/loss =0.05 mill
Strategy 2: Hedging using money market hedge
Money market hedge is a strategy used where exporter creates a liability in the form of short term loans in the same currency it expects to receive
In AUSTRALIA, the interest rate =
In UK, the interest rate =
1) Hogan will borrow _______ AUD to accumulate at 2.25% to the AUD value of its receipts.
Amount to borrow today : AUD28mill/(1+0.0225) =AUD 27.38 mill
2) Exchange this AUD27.38mill loaned amount into £ at today’s spot rate to receive: = £ 9.78 mill
3) Invest £9.78 mill at 1% in UK to accumulate £9.78 mill x (1+0.01) =£ 9.88 mill
Hogan’s profit under the following spot rates at t=3 will be:
a) If AUD 2.78/£
Profit/loss = £ 9.88 million - £10.07 million = -£ 0.19 million
b) If AUD 2.82/£
Profit/loss = -£0.05 million
Strategy 3: Using option hedging
Given in information number 3:
American put option
Gives the right to sell AUD at AUD 2.81/£
Premium = £ 200,000 (i.e. £0.2 million)
Hogan’s profit under the following spot rates at t=3 will be:
a) When AUD 2.78/£
If Hogan do nothing (i.e. sell AUD at