HEDGING TRANSACTION EXPOSURE
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Transcript of HEDGING TRANSACTION EXPOSURE
HEDGING TRANSACTION EXPOSURE
Jennifer NguyenCarlos Castillo
Case Background
Popescu, Hagi & Associates (PHA)Consulting firmDeals in specialized derivatives
DW, Inc.Computer manufacturerNo previous consistent hedging programHires PHA to implement a plan
Part I: The Hedging Problem
June 1996:DW orders Japanese parts valued at JPY 200,000,000Delivery due in 2 monthsPayment due 30 days from delivery
July 5, 1996Notification of October deliveryNo date set, but expected October 28Spot rate = .009062 USD/JPY
Historical Data
Based on percentage changes in monthly USD/JPY exchange rates from January 1971 to June 1996
306 observationsMean = .004423St Dev = .032948Minimum = -0.09844 on 11/30/1978Maximum = .134453 on 02/28/1973
Sensitivity Analysis
Best Case ScenarioJPY 200,000,000 x .009062 USD/JPY x (1 - .09844) = USD 1,633,982
Worst Case ScenarioJPY 200,000,000 x .009062 USD/JPY x (1 + .134453) = USD 2,056,082VAR interpretation: DW should have USD 2,056,082 to cover the payment
Distribution Assumption90% CI
VAR Upper JPY 200m x .009062 USD/JPY x 1.058458
USD 1,918,348
Lower JPY 200m x .009062 USD/JPY x 0.950388
USD 1,722,484
95% CI
VAR Upper JPY 200m x .009062 USD/JPY x 1.069001
USD 1,937,458
Lower JPY 200m x .009062 USD/JPY x 0.939845
USD 1,703,375
99% CI
VAR Upper JPY 200m x .009062 USD/JPY x 1.081192
USD 1,959,552
Lower JPY 200m x .009062 USD/JPY x 0.927654
USD 1,681,280
Distribution Assumption
VAR Interpretation95% CI: DW should have USD 1,918,349 to cover the payment97.5% CI: DW should have USD 1,937,458 to cover the payment99.5% CI: DW should have USD 1,959,552 to cover the payment
Standard – 97.5% confidence interval
PHLX Options - Calls
Calculating number of contracts:PHLX standard size of JPY 6,250,000 Underlying position = JPY 200,000,000Contract size = JPY 200,000,000/6,250,000 = 32 contracts
Premium CostJPY Dec 93 @ .75 = USD 15,000JPY Dec 96 @ .42 = USD 8,400
PHLX Cost Scenarios: JPY Dec 93
Strike Premium
Upfront Cost Opportunity Cost
.0093 .000075 USD 15,000 USD 424
Possible S
Exercise?
Expiration Cost
Total Cost
.0090 No USD 1,800,000 USD 1,815,424
.009062 No USD 1,812,400 USD 1,827,824
.0091 No USD 1,820,000 USD 1,835,424
.0093 No USD 1,860,000 USD 1,875,424
.0096 Yes USD 1,860,000 USD 1,875,424
.0098 Yes USD 1,860,000 USD 1,875,424
PHLX Cost Scenarios: JPY Dec 96
Strike Premium
Upfront Cost Opportunity Cost
.0096 .000042 USD 8,400 USD 238
Possible S
Exercise?
Expiration Cost
Total Cost
.0090 No USD 1,800,000 USD 1,808,638
.009062 No USD 1,812,400 USD 1,821,038
.0091 No USD 1,820,000 USD 1,828,638
.0093 No USD 1,860,000 USD 1,868,638
.0096 No USD 1,920,000 USD 1,928,638
.0098 Yes USD 1,920,000 USD 1,928,638
OTC Call Cost ScenariosStrike Premiu
mUpfront Cost Opportunity
Cost
.0091 .000096 USD 19,200 USD 453
Possible S
Exercise?
Expiration Cost
Total Cost
.0090 No USD 1,800,000 USD 1,819,653
.009062 No USD 1,812,400 USD 1,832,053
.0091 No USD 1,820,000 USD 1,839,653
.0093 Yes USD 1,820,000 USD 1,839,653
.0096 Yes USD 1,820,000 USD 1,839,653
.0098 Yes USD 1,820,000 USD 1,839,653
Forward Cost Scenario
6 month Forward point: .000238.009062 + .000238 = .0093JPY 200,000,000 x .0093 USD/JPY = USD 1,860,000Forward rate is regardless of spot rate at expiration
Comparison: Total Cost in USDPossible S
PHLX 93 PHLX 96 OTC 91 Forward
.0090 1,815,424 1,808,638 1,819,653 1,860,000
.009062 1,827,824 1,821,038 1,832,053 1,860,000
.0091 1,835,424 1,828,638 1,839,653 1,860,000
.0093 1,875,424 1,868,638 1,839,653 1,860,000
.0096 1,875,424 1,928,638 1,839,653 1,860,000
.0098 1,875,424 1,928,638 1,839,653 1,860,000
Recommendation
Based on the Total Cost associated with each derivative, we would recommend DW partake in the OTC option with strike price of .0091
Part II: Effective Total Cost
November 22, 1996Parts arrived on October 27th
Payment is due in five daysSpot Rate = .008973 USD/JPY
I: 3 month forward?July 5, 1996:
3 month Forward Point: .000109Spot rate = .009062Long position in forward contract
At Forward Expiration:JPY 200,000,000 x (.009062 USD/JPY + .000109 pts) = USD 1,834,200The JPY 200,000,000 could then be invested with a short term interest rate in Japan to recoup costs between October expiration and November payment date.
II: December Futures?
July 5, 1996:Dec IMM Futures = .009241Long position in futures contract
November 22, 1996:Dec IMM Futures = .008993Spot rate = .008973Short the futures contract
II: December Futures?
Effective Total Cost:Long July cost = USD 1,848,200Short Nov gain = USD 1,798,600Net loss of futures = USD 49,600• Discount loss from Dec to Nov = USD 234
Bought JPY 200,000,000 on November 22 @ .008973 = USD 1,794,600Total Effective Cost = 1,745,234
III: Unhedged
November 22, 1996Spot rate = .008973JPY 200,000,000 x .008973 USD/JPY = USD 1,794,600
IV: OTC Option
Call Option Strike Price .0091 @ .96Premium Cost = USD 19,200Opportunity Cost = USD 453
At November Expiration: Exercise?No, because spot price is below strike
Effective Total Cost:(JPY 200,000,000 x .008973 USD/JPY) + USD 19,653 = USD 1,814,253
V: PHLX Dec Call Options
JPY Dec 93Premium Cost = USD 15,000Opportunity Cost = USD 424
On November 22, 1996:Sell calls at .81 = USD 16,200
Effective Total Cost:(JPY 200,000,000 x .008973 USD/JPY) + USD 15,424 – USD 16,200 = USD 1,793,824
V: PHLX Dec Call Options
JPY Dec 96Premium Cost = USD 8,400Opportunity Cost = USD 238
On November 22, 1996:Sell calls at .15 = USD 3,000
Effective Total Cost:(JPY 200,000,000 x .008973 USD/JPY) + USD 8,638 – USD 3,000 = USD 1,800,238
Effective Total Cost Summary
Strategy Effective Total Cost
3-mo Forward USD 1,834,200
Dec Futures USD 1,745,234
Unhedged USD 1,794,600
OTC Nov Option USD 1,814,253
JPY Dec 93 PHLX USD 1,793,824
JPY Dec 96 PHLX USD 1,800,238
Hedging Transaction Exposure
Q & A?