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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.
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October 26, 2004
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.
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:
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).
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 $?
1. Expected Inflow of Foreign Currency:
2. Expected Outflow of Foreign Currency:
(using foreign currency interest rate as the discount rate).
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$/US$.
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:
Have a Great Day