Case 2: Hedging
Transaction Exposure
Sarah Scott and George Stoeckert
The Case
 December 2012: DW orders part from Japan, incurs a payable of
200,000,000.00 JPY
 Parts are received in April
 Payment due in May
Part I
Associated Risk: Best/Worst Case
Scenario
JPY
Exchange Rate
Multiplier
Outcome
Best Case Scenario
200,000,000.00
86.64
1.194209023 $
1,932,997.11
Worst Case Scenario
200,000,000.00
86.64
0.797795674 $
2,893,475.94
Range
$
960,478.83
Associated Risk: Simulated Distribution
$
99% Confidence Interval: 62,624.94
JPY
Transaction Exposure
Today
+/- Confidence Interval
Outcome
Range
Upper Bound
200,000,000.00
$
2,308,402.59
$
2,371,027.52
$
2,371,027.52
$
125,249.87
Lower Bound
200,000,000.00
$
2,308,402.59
$
2,245,777.65
$
2,245,777.65
5
7
Transaction Exposure Frequency
Frequency
58
53
45
31
17
1
14
5
11
22
24
27
50
45
34
27
19
11
10
8
8
4
Associated Risk: Normal Distribution
Normal Distribution
99% Confidence Interval:
0.007616709
JPY
Exchange Rate
Multiplier
Outcome
Upper Bound
200,000,000.00
86.64
1.007616709 $
2,290,953.06
Lower Bound
200,000,000.00
86.64
0.992383291 $
2,326,119.96
Range
$
35,166.90
Value at Risk Calculation
VaR:
Exchange Rate
JPY
α
σ
Δt
VaR
4mo
86.64 200,000,000.00
2.326347874
0.068459336
1$
367,636.73
5mo
86.64 200,000,000.00
2.326347874
0.068459336
1.25 $
459,545.91
Δt in terms of 4 months
PHLX Options
Estimated Spot
Rate
Calls
Option
Total Option Total Premium
Price
Price
Premium
Total Combined
Price
April Spot
Rate
April Close
Out
April Close Out +
Premium
Probability Exercise Option?
0.012312687
PHLX Option
June .008
0.008
0.004583
$
1,600,000.00
$
916,600.00
$
2,516,600.00
0.012312687
$
2,462,537.36
$
3,379,137.36
8.21%
YES
0.012527612
PHLX Option
June .008
0.008
0.004583
$
1,600,000.00
$
916,600.00
$
2,516,600.00
0.012527612
$
2,505,522.35
$
3,422,122.35
14.37%
YES
0.012742537
PHLX Option
June .008
0.008
0.004583
$
1,600,000.00
$
916,600.00
$
2,516,600.00
0.012742537
$
2,548,507.35
$
3,465,107.35
10.82%
YES
Estimated Spot
Rate
Calls
Option
Premium
Total Option Total Premium
Price
Price
Total Combined
Price
April Spot
Rate
April Close
Out
Close Out + Premium
Probability Exercise Option?
0.012312687
PHLX Option
June .009
0.009
0.0036255
$
1,800,000.00
$
725,100.00
$
2,525,100.00
0.012312687
$
2,462,537.36
$
3,187,637.36
8.21%
YES
0.012527612
PHLX Option
June .009
0.009
0.0036255
$
1,800,000.00
$
725,100.00
$
2,525,100.00
0.012527612
$
2,505,522.35
$
3,230,622.35
14.37%
YES
0.012742537
PHLX Option
June .009
0.009
0.0036255
$
1,800,000.00
$
725,100.00
$
2,525,100.00
0.012742537
$
2,548,507.35
$
3,273,607.35
10.82%
YES
Estimated Spot
Rate
Calls
Option
Premium
Total Option Total Premium
Price
Price
Total Combined
Price
April Spot
Rate
April Close
Out
Close Out + Premium
Probability Exercise Option?
0.012312687
PHLX Option
June .01
0.01
0.0029542
$
2,000,000.00
$
590,840.00
$
2,590,840.00
0.012312687
$
2,462,537.36
$
3,053,377.36
8.21%
YES
0.012527612
PHLX Option
June .01
0.01
0.0029542
$
2,000,000.00
$
590,840.00
$
2,590,840.00
0.012527612
$
2,505,522.35
$
3,096,362.35
14.37%
YES
0.012742537
PHLX Option
June .01
0.01
0.0029542
$
2,000,000.00
$
590,840.00
$
2,590,840.00
0.012742537
$
2,548,507.35
$
3,139,347.35
10.82%
YES
Frequency Distribution: 4-Month
Changes
Frequency Percentage: Four-Month Changes in Spot Rate
16.000%
14.000%
12.000%
10.000%
8.000%
6.000%
4.000%
2.000%
0.000%
Percentage
OTC Options:
Estimated Spot
Calls
Rate
Option
Premium
Total Option Total Premium
Price
Price
$
0.012309668OTC Option March .009 0.0090
$
$
0.0040810 1,800,000.00
$
0.012508258OTC Option March .009 0.0090
$
$
0.0040810 1,800,000.00
$
0.012706848OTC Option March .009 0.0090
$
$
0.0040810 1,800,000.00
Estimated Spot
Calls
Rate
Option
Premium
0.012309668
$
$
0.0031976 2,000,000.00
0.012508258
OTC Option March .01 $
0.0100
$
$
0.0031976 2,000,000.00
0.012706848
OTC Option March .01 $
0.0100
$
$
0.0031976 2,000,000.00
March Spot
Rate
March Close March Close Out +
Out
Premium
Probability
Exercise
Option?
$
816,200.00
$
77,449.03
$
2,538,750.97
0.012309668
$
2,461,933.60
$
3,278,133.60
10.43%
YES
$
816,200.00
$
77,449.03
$
2,538,750.97
0.012508258
$
2,501,651.56
$
3,317,851.56
12.66%
YES
$
816,200.00
$
77,449.03
$
2,538,750.97
0.012706848
$
2,541,369.52
$
3,357,569.52
12.48%
YES
Total Option Total Premium
Price
Price
OTC Option March .01 $
0.0100
Interest Earned Total Combined Price
Interest Earned Total Combined Price
March Spot
Rate
March Close March Close Out +
Out
Premium
Probability
Exercise
Option?
$
639,520.00
$
77,449.03
$
2,562,070.97
0.012309668
$
2,461,933.60
$
3,101,453.60
10.43%
YES
$
639,520.00
$
77,449.03
$
2,562,070.97
0.012508258
$
2,501,651.56
$
3,141,171.56
12.66%
YES
$
639,520.00
$
77,449.03
$
2,562,070.97
0.012706848
$
2,541,369.52
$
3,180,889.52
12.48%
YES
Frequency Distribution: 3-Month
Changes
Frequency Percentage: 3 Month Changes
12.663% 12.477%
10.428%
9.311%
9.497%
9.497%
6.518%
5.400%
2.607%
1.490%
0.186%
0.000%
0.186%
0.745%
5.214%
3.166%
2.607%
3.724%
1.304%
0.559%
0.372%
Percentage
1.117%
0.372%
0.559%
Forward Alternative
Requirement (Due March 15th)
200,000,000.00
Current Exchange Rate JPY/USD (12/15/12)
0.01247
Interest Rate US 6mo
0.26205
Interest Rate Japan 6mo
0.15158
Forward Rate Dec 6- May 17
6-Month Forward Contract Cost
0.013666
$
2,733,247.10
Cost Comparison: Hedging Alternatives
Price Comparison: Hedging Strategies
Forward 6 Month
Forward 3 Month, Invest Japanese Bank
OTC Option March .009
PHLX Option June .008
$2,733,247.10
$2,421,350.97
$2,538,750.97
$2,516,600.00
Part II
Hedging Transaction Exposure
What would be the effective total cost (in USD) of the
Japanese parts if you had advised…
 Using three months forward?
 Long 3 Month Forward (Dec & March)
 (Dec-Mar) 200,000,000 JPY * .012494 (3 Month FR) = $2,498,800.00
 Rolled into new 3 month Forward and calculated the new 3 Month Forward Rate in March
2015: .01061253
 (Mar-June) 200,000,000 JPY * .0161253 = $2,122,505.97
 Cash Outflows from transactions = $374,955.82 + $106,580.16
 Short 1 Month Forward (May-June)
 Shorted 1 Month Forward to Close Position with opposite transactions
 (May-June) 200,000,000 JPY * .010464 (1 Month Forward) = $2,092,800
 Cash inflow from transactions = $76,874.19
 Cost of Forward Premiums = $404,461.79
 Value of JPY in May = $2,008,000.00
 Total Cost (excluding other undocumented fees) = $2,412,461.79
What would be the effective total cost (in USD) of the
Japanese parts if you had advised…
 Using six months forward?
 (Dec-June) Long 6 Month JPY Forward
 200,000,000 JPY * 0.012561 (6 Month FR) = $2,512,200.00
 Value of JPY in June = $2,015,925.65
 Cash Outflow of $496,274.19
 (May-June) Short 1 Month JPY Forward
 200,000,000 JPY * .010464 (1 Month FR) = $2,092,800
 Cash Inflow of $76,874.19
 Cost of Forward Premiums = $419,400
 Value of JPY in May = $2,008,000.00
 Total Cost (excluding other undocumented fees) = $2,427,400
What would be the effective total cost (in
USD) of the Japanese parts if you had
advised…
 Using June Futures?
 Long (Dec-June) 200,000,000 JPY * .01257 (June Future Rate) = $2,514,000.00
 Cash Outflow
 Close position with Short (May-June) 2000,000,000 JPY * .010002 = $2,000,400.00
 Cash Inflow
 Total Cost of Future Premiums = $513,600
 Value of JPY in May = $2,008,000.00
 Total Cost of Future = $2,521,600
What would be the effective total cost (in USD) of the
Japanese parts if you had advised…
 Using the OTC JPY Option?
OTC
March 17th
March 17th
March 17th
March 17th
Strike
Premium
Premium $
Price
Premium
Total Cost
0.009
0.004081
0.004081 $ 1,800,000.00 $ 816,200.00 $ 2,616,200.00
0.010
0.0031976
0.0031976 $ 2,000,000.00 $ 639,520.00 $ 2,639,520.00
Ex. Rate May Strike/Spot Delta Execute
0.01004
0.00104 Y
0.01004
4E-05 Y
Call Value
Profit/Loss
Total Value
$ 208,000.00 $ (608,200.00) $ 2,616,200.00
$
8,000.00 $ (631,520.00) $ 2,639,520.00
 Call Both Options
 Invest JPY on March 17th = 200,000,000 *1.04595 = 200,091,880 JPY
 Interest Earned = 91,880 JPY
 Purchase JPY for Payment = 200,000,000 * .01004 = $2,000,8000.00
 Convert Interest = 91,880 JPY * .01004 = $922.47
 OTC .009 Total Cost = $2,616,200 - $922.47 = $2,615,277.53
 OTC .010 Total Cost = $2,639,520 - $922.47 = $2,638,597.53
What would be the effective total cost (in USD) of the
Japanese parts if you had advised…

If the PHLX June Options had been…
PHLX
Strike
June .008 (Call)
June .009 (Call)
June .010 (Call)
Premium (Cents) Premium $
0.008
0.20465 0.0020465
0.009
0.10592 0.0010592
0.01
0.29542 0.0029542
PHLX
Ex. Rate May
Strike/Spot Delta
June .008 (Call)
0.0100
0.00204
June .009 (Call)
0.0100
0.00104
June .010 (Call)
0.0100
4.00E-05
Execute
Y
Y
Y
Exercise Value
$
1,600,000.00
$
1,800,000.00
$
2,000,000.00
Premium
$ 409,300.00
$ 211,840.00
$ 590,840.00
Total Cost
$ 2,009,300.00
$ 2,011,840.00
$ 2,590,840.00
Call Value
408,000.00
208,000.00
8,000.00
Profit/Loss
$
(1,300.00)
$
(3,840.00)
$ (582,840.00)
Total Cost of JPY
$ 2,009,300.00
$ 2,011,840.00
$ 2,590,840.00

Total Cost of JPY with (June .008 Call) = $2,009,300.00

Total Cost of JPY with (June .009 Call) = $2,011,840.00

Total Cost of Option (June .010 Call) = $2,590,840.00
What would be the effective total cost (in USD) of the
Japanese parts if you had advised…
 Left Position Open?
 Value of JPY in USD (Dec 2012) = $2,308,402.59
 Additional Interest Income (Low Interest Rate Assumed) = $4,439.83
 $2,308,402.59 * (.23%/6*12*(150/360)) = $4,439.83 Cash Inflow
 Value of JPY in May = 200,000,000 (JPY) * .01004 (St) = $2,008,000 USD
 Total Cost of JPY Less Additional Interest Income = $2,003,560.17
Final Comparison
Open Position Is Most Risky but Least Expensive
 Left Position Open
 $2,003,560.17
 PHLX
 $2,009,300.00
 3 Month Forwards
 $2,412,461.79
 6 Month Forwards
 $2,427,400.00
 Futures
 $2,521,600.00
 OTC
 $2,615,277.53