Professor Ted Azarmi's Forum

Guest


Author Topic: Hedging the transaction exposure  (Read 15807 times)

Offline paula.schliessler

  • President Member
  • **************
  • Posts: 14
Hedging the transaction exposure
« on: May 21, 2009, 01:55:49 pm »
Find attached my solution. Paula Schliessler

Class exercise- Transaction and translation exposure- Paula Schliessler

Data from Financial Times:

•   US $ 1 year treasury bonds: 0,48% interest rate
•   UK £ 1 year treasury bond 0,65% interest rate
•   S= Spot rate=  1,5095 $/ 1 £ or 0,662471 £/ 1 $
•   F=1 year Forward rate= 1,507 $/ 1 £ or 0,66357 £/ 1 $

Interest rate parity: F/S = 1+R($)/ 1+R(£)=0,99834 holds.

Example:
Firm A from UK buys goods from firm B in US. Firms A has to pay 1000 pounds in 1 year to firm B. Firm B then will want to have US Dollars instead of pounds. There is a currency risk.

3 possibilities to hedge the transaction exposure

1. Forward cover
The 1000 pounds that firm B gets in one year will either be exchanged at the spot rate in one year, or  you do a forward cover. For this firms B makes a forward contract saying that it will pay 1000 pounds in one year and get it exchanged for the forward rate . As we assume that the spot rate will fall, a forward cover makes sense to insure yourself against a possible loss.
In one year then, firm B gets 1000 pounds, pays the forward contract with it and gets 1000 pound * forward rate= 1000 pounds *  1,507 $/ 1 £ =1507 dollars.
If at that point of time the spot rate was 1,500$/ 1 £ firm B would get only 1500 dollars. So the forward contract was a good solution.

2. Money market hedge
Firm B gets 1000 pounds in one year from firm A. To insure themselves against the exchange rate risk, as they will want dollars then( they would have to exchange they pounds for dollars as they are a US firm) they do a money market hedge. Trick: They take a loan of 993,54198 pounds  at the interest rate of 0,65% in the UK. This can then be paid back by what firm B gets from A, 1000 pounds in one year. The 993, 54198 pounds then will be exchanged in dollars at the spot rate, 993, 54198 pound * 1, 5095 $/ 1 £= 1499, 75 dollars. This firm A loans at the US dollar market and gets an interest rate of 0,48%. Getting 1, 0048 * 1499,75=1506,95 dollars in one year. They don’t have to pay attention to the currency risk any more as they only deal with their home currency. So if you are unsure about the development of exchange rates this is a good idea.

3. Option market hedge
Firm B gets 1000 pounds in one year from firm A. They can exchange them then at the spot rate in one year. They can also buy a put option to have a certain fixed exchange rate in one year to sell the 1000 pounds .This means they can exchange the 1000 pounds at the fixed rate in the contract. But they don´t have to. If e.g the spot rate in one year is higher they will not use the option as it would make them worse off. The option is an insurance against the fall of the spot rate, but leaves the option to profit from the fall of it. This is really good, but you have to consider that there is a price for buying the option. The brokerage fee and cost of contract.
So you have the option to exchange 1000 pounds at 1,507 $/ 1 £ in one year. The cost would be 0,002 dollar  option premium per pound exchanged and 1 dollar brokerage fee. So 1000*0,002 + 1= 3 pounds. So you are left with 1507 dollar minus 3 dollar= 1504 dollar.
If the spot rate in one year is lower then the option exchange rate you use the option and have successfully insured yourself. If the spot rate in one year is higher you do not use the option you bought and you only had the cost for the option, which was probably worth its use of eliminating your currency risk.


« Last Edit: July 30, 2009, 09:39:49 pm by Ted Azarmi »

Offline bbruggem

  • Hero
  • ***************
  • Posts: 15
Re: Hedging the transaction exposure
« Reply #1 on: May 21, 2009, 01:57:15 pm »
Please find attached the homework.

Kind regards,
Bettina Brüggemann

Please register for the board to see the attached files.
« Last Edit: December 13, 2009, 08:58:25 pm by Ted Azarmi »

Offline ChristianHattendorff

  • President Member
  • **************
  • Posts: 14
Re: Hedging the transaction exposure
« Reply #2 on: May 21, 2009, 07:35:48 pm »
Please find my solution attached.

Best regards,
Christian Hattendorff

Offline Michal Wilczek

  • Hero
  • ***************
  • Posts: 15
Re: Hedging the transaction exposure
« Reply #3 on: May 22, 2009, 11:47:15 am »
Solution attached.

Michal Wilczek

Offline ellmar

  • President Member
  • **************
  • Posts: 14
Re: Hedging the transaction exposure
« Reply #4 on: May 22, 2009, 04:38:31 pm »
Homework is attached.
Best regards
Ellmar Jungschaffer

Offline shohendorff

  • President Member
  • **************
  • Posts: 14
Re: Hedging the transaction exposure
« Reply #5 on: May 24, 2009, 11:29:55 pm »
please find my homework attached.

Best regards
Stephanie Hohendorff

Offline DanielGebauer

  • President Member
  • **************
  • Posts: 14
Re: Hedging the transaction exposure
« Reply #6 on: May 26, 2009, 11:57:20 pm »
Please find my homework attached.



Best regards,

Daniel Gebauer

Offline florian totzauer

  • President Member
  • **************
  • Posts: 14
Re: Hedging the transaction exposure
« Reply #7 on: May 28, 2009, 12:02:41 am »
Please find homework attached
Kind regards
Florian Totzauer

Offline toshiya_diru

  • Silver Member
  • *****
  • Posts: 5
Re: Hedging the transaction exposure
« Reply #8 on: May 28, 2009, 12:08:36 pm »
homework is attached

Cui Jinjing

Offline CProebsting

  • Super Hero
  • ****************
  • Posts: 16
Re: Hedging the transaction exposure
« Reply #9 on: May 28, 2009, 12:40:00 pm »
Please find homework attached,

Regards,
Christian Pröbsting

Offline Chrizzo

  • Platinum Member
  • *******
  • Posts: 7
Re: Hedging the transaction exposure
« Reply #10 on: May 28, 2009, 03:29:32 pm »
please find my solution attached.

warm regards,
Christoph Schröder

Offline simonevogelgsang

  • Super Hero
  • ****************
  • Posts: 17
Re: Hedging the transaction exposure
« Reply #11 on: May 28, 2009, 09:30:56 pm »
Please find my solution attached.
Best regards.
Simone Vogelgsang

Offline larissa

  • President Member
  • **************
  • Posts: 14
Re: Hedging the transaction exposure
« Reply #12 on: May 29, 2009, 10:00:02 am »
Soution attached.

Best regards,
Larissa Mader

Offline leoniekrauss

  • Super Hero
  • ****************
  • Posts: 16
Re: Hedging the transaction exposure
« Reply #13 on: May 31, 2009, 05:48:05 pm »
My homework is attached.

Have a nice holiday!

Leonie Krauß

Offline HannahHerrmann

  • Super Hero
  • ****************
  • Posts: 17
Re: Hedging the transaction exposure
« Reply #14 on: June 01, 2009, 04:58:20 pm »
My homework is attached

Best regards,
Hannah Herrmann