1 / 18

International Finance

International Finance. Hedging Transaction Exposure Bill Reese. Learning Objectives. In this unit we will learn: How to hedge foreign exchange transaction exposure through: Forward contracts Futures contracts Options on futures contracts Money market hedges. Transaction Exposure.

fionn
Download Presentation

International Finance

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. International Finance Hedging Transaction Exposure Bill Reese

  2. Learning Objectives • In this unit we will learn: • How to hedge foreign exchange transaction exposure through: • Forward contracts • Futures contracts • Options on futures contracts • Money market hedges

  3. Transaction Exposure • Daimler Chrysler wants to build new plant in Germany • Construction bids to be in euros • Your firm bids €100 million • Spot rate at time of bid is 1.22 $/€ • $122 million

  4. Transaction Exposure • One month later – you find out you won the bid • XR is now 1.15 $/€ • $115 million – lost $7 million • Eight months to build plant • Three more months to be paid • This is transaction exposure

  5. Simple Hedge • As much as possible – match assets and liabilities in same currency • Pay for building supplies and wages in euros • If euro depreciates – so does cost of building the plant

  6. Hedging • Forward contract • Futures contract • Option on futures contract • Money market hedge

  7. Forward Contract • Euros receivable is an asset • Need to create a euro liability • Forward contract to sell €100 million in one year • Locks in XR • Usually contract with a bank

  8. Futures Contract • Standardized forward contract at an exchange • Traded on Chicago Mercantile Exchange • €125,000 per contract • Delivery last month of each quarter

  9. Futures Contract • Advantages of Futures Contract • No hunting for counterparty • No counterparty default risk • Actual delivery not necessary

  10. Futures Contract • Disadvantages of Futures Contract • Standardized contract • Size • Delivery date • Currency • Marked-to-market

  11. Options on Futures • Suppose you hedge with futures contract • Short 800 contracts at 1.10 $/€ • Lock-in sale of €100 million for $110 million • 800 contracts at €125,000/contract

  12. Options on Futures • What if spot rate at delivery is 1.30 $/€? • Regret • Euro appreciated • Lost opportunity for gain • Futures contract is insurance

  13. Options on Futures • Option on futures contract is best of both worlds • Enter contract if euro depreciates • Do not enter contract if euro appreciates • There is a catch

  14. Options on Futures • Premium • Paid at time you purchase option • Based on • Futures contract XR(strike price) • Current spot XR • Volatility of XR • Time till expiration of option • Interest rates

  15. Options on Futures • Advantage over futures contract • Choice (option) of entering into futures contract • Disadvantage relative to futures contract • Premium

  16. Money Market Hedge • Create a liability to offset asset • Want to owe €100 million in a year • Borrow PV of €100 million • Convert borrowed euros to dollars at spot rate

  17. Money Market Hedge • Assume • Annual interest rate is 5% • Spot rate is 1.22 $/€

  18. Money Market Hedge • PV = FV / (1+r)t • = €100 million / 1.05 • = €95.238 • Convert to $ at spot rate €95.238 x 1.22 $/€ = $116.19 million today

More Related