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.
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
Parts Ordered worth
JPY 200MM
June ‘09
Delivery Due Date
Aug ‘09
Payment due (200MM)
October 2009
Measuring the Transaction
Exposure (TE)
Net Transactional Exposure:
JPY 200MM * 0.0098290 = $1,965,800.
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
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
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
Cash Flow from Forward Contract
Strategy ICF
ST < St
ST > St
6mth Forward Contract $ - $ 1,960,600.00 $ 1,960,600.00
Cash Flow from OTC Call Options
Strategy
ICF
Buy Dec 0.0096
($110,420)
ST < K
ST > K
0 200MM (ST - 0.0096)
Nov 17 OTC Call .0096
6 mnth Forward Contract
USD 1.9606MM
USD 0.11042MM
K
ST
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 6th and the Parts were
delivered October 11th. Payment due November
11th
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 Dec
Calls
Puts
.0096
.00055 .00668
.0098
.00030 .00843
.0100
.00015 .10288
PHLX Dec JPY Options – June
JPY Dec
Calls
Puts
.0096
.07009 .04308
.0098
.05978 .05261
.0100
.05058 .06325
OTC JPY Options – Exp. Nov. 17
Strike Price
Calls
Puts
.0096
.06562 .03921
.0098
.05521 .04866
Effective Total Cost in USD if we had
advised…
1)
2)
3)
4)
5)
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
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
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
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
Strike Price
.0096
.0098
– Exp. Nov 17
Calls
Puts
.06562 .03921
.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 JPY Dec Option
PHLX Dec JPY Options – From Nov.
JPY Dec
Calls
Puts
.0096
.00055 .00668
.0098
.00030 .00843
.0100
.00015 .10288
PHLX Dec JPY Options – From June
JPY Dec
Calls
Puts
.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