Transaction Exposure Flashcards
What is Transaction Exposure?
The domestic currency value of future cash flows denominated in foreign currency fluctuates with changes in the foreign exchange rate
Boeing sells £100 million worth of jets to -British Airways with payment due in one year.
- US interest rate = 6.1%
- UK interest rate = 9%
- S($/£) = 1.50
- F12($/£) = 1.46
- What is the % forward premium/discount?
- Is IRP holding?
- (F-S)/S - (1.46-1.5)/1.5 = =.0266*100 = 2.66% Discount
- F = 1.5(1.061/1.09) = 1.4600917 (not quite)
Boeing sells £100 million worth of jets to -British Airways with payment due in one year.
- US interest rate = 6.1%
- UK interest rate = 9%
- S($/£) = 1.50
- F12($/£) = 1.46
- In a forward hedge what would you do?
- If the Spot in 12 months goes to $1.50 or $1.40 what is the gain loss?
- Payment is $146,000,000 in 12 months.
- If S12($/£) = 1.5 then $4 million potential loss
- If S12($/£) = 1.4 then$6 million potential gain
- For a forward hedge what is the Gain equation?
- For a receivable, what is gain/loss when the spot rate is equal to, less than, greater than the forward rate?
- Gain = (F12-S12) * Amount
- If Ŝ12 ≈ F then no loss with hedging.
- If Ŝ12 < F then gain with hedging.
- If Ŝ12 > F then loss with hedging.
Boeing sells two 737 jets to British Airways for £100 million with payment due in one year.
US interest = 6.1% UK interest = 9%
S($/£) = 1.50 F12($/£) = 1.46
-What are the steps for a Money Market Hedge?
-Conduct the calculations for the hedge
-Borrow pounds, convert to dollars and invest in U.S.
-Step 1) Borrow an amount that would yield £100 million in one year.
= £100 million/1.09 = £ 91,743,119
-Step 2) Convert pounds to dollars.
£ 91,743,119 at S($/£) = 1.50 = $137,614,678
-Step 3) Invest dollars at US interest = 6.1%
= $137,614,678 (1.061) = 146,009,174
-When IRP is holding and not holding what happens with the Forward Hedge and Money Market Hedge?
When it’s holding the Forward Hedge and MM Hedge will be the same and when it’s not holding it won’t be.
Boeing sells two 737 jets to British Airways for £100 million with payment due in one year.
US interest = 6.1% UK interest = 9%
S($/£) = 1.50 F12($/£) = 1.46
Strike Price $1.46/ £, Premium is $.02 per pound
-What is the total cost of the option?
-What if pound appreciates to $1.50 in one year, what would you do, and what is the gain/loss?
- What if pound depreciates to $1.40 in one year, what would you do, and what is the gain/loss?
- Cost is $2 million for the option plus the forgone interest at the US interest rate of 6.1%, so total cost = $2,122,000
- Let option expire, £100 million*1.5 = $150,000,000- $2,122,000 = 147,878,000 > 146,000,000, Gain of $1,878,000 over the 1.46 rate.
- Exercise option, £100 million*1.46 = 146,000,000- $2,122,000 = 143,878,000
For hedging a foreign currency receivable what are you available options?
1) Sell foreign currency in the forward market
2) Borrow foreign currency in the money market and invest in domestic currency.
3) Buy a put for the foreign currency.
Boeing sells 777 jets to TAM in Brazil for R$500 million.
US interest rate = 1% & Brazil interest = 8%
S($/R$) = .50 F12($/R4) = .46759259
1) Show actions in forward hedge.
2) Show actions in money market hedge.
3) Show actions in options given .47 put premium, Premium at .003 per real. Show the gain or loss if S12 = .6 S12 = .4
1) Sell R$500 million at F12($/R4) = .46759259, Receive $233,796,296 in one year.
2) Borrow Reals R$500 million/ 1.08 = R$462,962,962
Convert to dollars: R$462,962,962(.5) = $231,481,481
Invest in US at 1% $231,481,481 (1.01) = $233,796,296
3) Sell R$500 million at .47 strike price
Premium at .003 per real = $1,500,000
Total cost with interest $1,515,000
If S12 ($/R$)= .6 – let it expire
R$500 million * .6 = $300 million - $1,515,000 = $298,485,000
If S12 = .4 – Exercise at .47
R$500 million * .47 = $235 million - $1,515,000 = $233,485,000
Boeing purchases engines from Rolls-Royce for £100 million payable in 1 year.
US interest rate = 6.1%
UK interest rate = 9%
S($/£) = 1.50 F12($/£) = 1.46
1) What should you do for a Forward Hedge
2) What should you do for MM Hedge?
1) Buy £100 million @ F12($/£) = 1.46
In one year pay $146 million
2) To have £100 million in one year, invest in UK at the given interest rate of 9%
Need £100 million /1.09 = £ 91,743,119
At the current spot S($/£) = 1.50
Take £ 91,743,119(1.5) = $137,614,679 today Plus foregone interest in the U.S.
= $137,614,679 * 1.061 = $146,009,174
Boeing purchases engines from Rolls-Royce for £100 million payable in 1 year.
US interest rate = 6.1%
UK interest rate = 9%
S($/£) = 1.50 F12($/£) = 1.46
At a strike price of 1.46, Premium $.018 per pound
1) What should you do for a Option Hedge?
If the pound appreciates S12($/£) = 1.5
If the pound depreciates S12($/£) = 1.4
1) Cost of option, $1.8 million, plus forgone interest, $109,800, total cost = $1,909,800
-Exercise call, £100 million1.46 = $146,000,000 + $1,909,800 = 147,909,800 > 146,000,000
-Let the call expire, £100 million1.4 = $140,000,000 + $1,909,800
= 141,909,800
Compare receivables and payables, what do you do for a forward hedge, MM hedge, and option hedge for both scenarios?
1) Receivables - Sell foreign currency in the forward market, Borrow foreign currency in the money market and invest in domestic currency. Buy a put for the foreign currency.
2) Payables - Buy foreign currency in the forward market, Invest in foreign currency in the money market. Buy a call for the foreign currency.
What is Cross Hedging?
Hedging a position in one asset by taking a position in another asset. Assets need to be highly correlated
What is Contingent Exposure, and what type of hedge best goes with this?
The risk involved in not knowing something for a time and the exchange rate changing in the meantime. Use options for this type of hedge, gives flexibility.
Ex. Bidding on a project and you won’t know for 3 months if you have it or not.
What is a Currency Swap?
Agreement to swap cash flows in one currency for cash flows in another currency at a predetermined exchange (the swap rate). Usually happens when companies have recurring payments.
