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Hedging Transaction Exposure. Popescu, Hagi & Associates. Presented by: Frank Naglieri and Kariuki Ndegwa. Problem. In June 2009, DW ordered Japanese parts valued at JPY 200,000,000. Delivery is due in two months. Payment is due within 30 days of delivery.

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hedging transaction exposure popescu hagi associates

Hedging Transaction Exposure. Popescu, Hagi & Associates

Presented by:

Frank Naglieri and Kariuki Ndegwa

problem
Problem
  • In June 2009, DW ordered Japanese parts valued at JPY 200,000,000.
  • Delivery is due in two months.
  • Payment is due within 30 days of delivery.
  • The exact delivery date could not be guaranteed, but an informal telephone call from Japan stated the expected delivery date to be October 17.
time line
Time Line

Parts Ordered worth

JPY 200MM

Payment due (200MM)

Delivery Due Date

June ‘09

October 2009

Aug ‘09

measuring the transaction exposure te
Measuring the Transaction Exposure (TE)
  • Net Transactional Exposure:

JPY 200MM * 0.0098290 = $1,965,800.

range estimates of transaction exposure
Range Estimates of Transaction Exposure
  • Using ad-hoc method:

+/- 10% of Net Transactional Exposure

$1,965,800 + $196,580 = $2,162,380

$1,965,580 - $196,580 = $1,769,000

  • Using sensitivity analysis:

Max daily change 3.47% and Min daily change

-5.58% from Jan 2001

$1,965,800 * (1 + 0.0347) = $ 2,034,013

$1,965,800 * (1 – 0.0558) = $1,856,108

range estimates of transaction exposure1
Range Estimates of Transaction Exposure
  • Another sensitivity analysis:

Max Daily Forex Rate 0.011586 and Min Daily Forex Rate 0.007421

JPY200,000,000 * 0.011586 = $2,317,200

JPY200,000,000 * 0.007421 = $1,484,200

  • Using random forex rates with a normal distribution
phlx options
PHLX Options
  • 1 options contract in USD/JPY = JPY 100MM
    • Therefore JPY200MM / JPY100MM = 200 contracts are needed to hedge the short position.
  • For OTC options:

(0.0098 strike price) 0.05521 * 200MM = $110,420

(0.0096 strike price) 0.06562 * 200MM = $131,240

  • For Exchange Traded Options:

(0.0098 strike price) 0.05978 * 200MM = $119,560

(0.0096 strike price) 0.07009 * 200MM = $140,180

  • OTC options are cheaper than PHLX options.
forward contract vs options hedge
Forward Contract vs. Options Hedge

Cash Flow from Forward Contract

Cash Flow from OTC Call Options

slide9

Nov 17 OTC Call .0096

6 mnth Forward Contract

USD 1.9606MM

USD 0.11042MM

ST

K

recommendation
Recommendation
  • I would recommend that Mr. Mirman to use the OTC options for the following reasons:
    • The expiry date of the OTC options match exactly the date the company needs to make payment to their supplier ( November 17th 2009)
    • The OTC options guarantee that the company does not pay more than (0.0096 * JPY 200MM - $110,420) while allowing the company to also benefit from the upside in case the Yen declines relative to the USD.
it is now november 6 th and the parts were delivered october 11 th payment due november 11 th
Spot Rate

.008985 USD/JPY

Forward Rates

1 month - .0089845

3 month - .008985

U.S. Int. Rates: < 2 months

Deposit Rate: .2909

Borrowing Rate: .3165

CME Dec. Futures

.008987

PHLX Dec JPY Options – Nov.

JPY DecCallsPuts

.0096 .00055 .00668

.0098 .00030 .00843

.0100 .00015 .10288

PHLX Dec JPY Options – June

JPY DecCallsPuts

.0096 .07009 .04308

.0098 .05978 .05261

.0100 .05058 .06325

OTC JPY Options – Exp. Nov. 17

Strike PriceCallsPuts

.0096 .06562 .03921

.0098 .05521 .04866

It is now November 6th and the Parts were delivered October 11th. Payment due November 11th
effective total cost in usd if we had advised
Effective Total Cost in USD if we had advised…
  • 3-month Forward Contract
  • Using December Futures
  • Left the Position Open
  • Using the OTC JPY Option
  • Using PHLX JPY Dec Options
effective cost of using 3 month forward
Effective Cost of Using 3 Month Forward

June 6th Sept 6th

3 Month Forward:

200M JPY x .008985 = $1,797,000

Sept 6th Dec 6th - Rollover 3 Month Forward

200M JPY x .008985 = $1,797,000

Using 3 month forward contracts between June and September

and then rolling it over again the cost is a zero sum and the hedge

is perfect.

June 6th Sept 6th

3 Month Forward:

200M JPY x .008985 = $1,797,000

Sept 6th Oct 6th - 1 Month Forward Contract

200M JPY x .0089845 = $1,796,900 USD

Oct 6th Nov. 6th - Rollover 1 Month Forward Contract

200M JPY x .0089845 = $1,796,900 USD

The difference in USD we would have to pay ultimately is:

$1,797,000 - $1,796,900 = $100 in costs

effective cost of using december futures
Effective Cost of Using December Futures

Dec. Futures (Nov. Info) –200M JPY x .008987 = $1,797,400 USD

Dec. Futures (June Info)– 200M JPY x .009873 = $1,974,600 USD

Nov. Spot Rate–200M JPY x .008985 = $1,797,000 USD

Dec Futures (Nov. Info) vs. Nov. Spot Rate:

$1,797,400 - $1,797,000 = $400 USD in Costs

Dec Futures (Nov. Info) vs. Dec. Futures (June Info):

$1,974,600 USD - $1,797,400 USD = $177,200 USD in Costs

Using the December Futures given to us in November or June is not a cost effective hedging

tool. Compared to the November Rate the December Futures given to us in November would

cost an extra $400 of USD in order to hedge the 200M JPY. If you compared the December

Futures given to us in June and November you would see there is a $177,200 of extra USD we

would pay to hedge the 200M JPY.

effective cost of leaving position open
Effective Cost of Leaving Position Open

June Conversion

November Conversion

( 200M JPY * .009829) – (200M JPY * .008985)

= 1,952,800 – 1,797,000 = ($168,800)USD Costs

If we let the exchange rates take their course

we would be better off waiting to convert the

funds in November rather than June

because the Spot Rate is more favorable in

November vs. June.

effective cost of using otc jpy option
OTC JPY Options – Exp. Nov 17

Strike PriceCallsPuts

.0096 .06562 .03921

.0098 .05521 .04866

We assume we bought the call back in June with the Strike Price of .0096. Since the Spot Rate is favorable compared to the Strike Price we shouldn’t exercise the call. So our costs would be the premium of buying the call back in June but not exercising the option.

200M JPY * .06562

= 13,124,000/100 = ($131,240) USD Costs

Effective Cost of Using OTC JPY Option
effective cost of using jpy dec option
PHLX Dec JPY Options – From Nov.

JPY DecCallsPuts

.0096 .00055 .00668

.0098 .00030 .00843

.0100 .00015 .10288

PHLX Dec JPY Options – From June

JPY DecCallsPuts

.0096 .07009 .04308

.0098 .05978 .05261

.0100 .05058 .06325

We still assume we buy a call option at

the .0096 in June. Since in both cases

we wouldn't exercise the option since the

Spot Rate is more favorable than the Strike

Price we would compare the 2 premiums we

pay for not exercising the calls in June and

November.

June Premium

200M JPY * .07009 = $14,018,000/100

= ($140,180) USD Costs

November Premium

200M JPY * .00055 = ($110,000) USD Costs

If we used the Dec. option in November

instead of June we would have saved

$40,180 in premium payments.

$140,180 - $ 110,000 = $40,180

Effective Cost of Using JPY Dec Option