Baggins Co': How Well Did AILs Treasury Do

1
Baggins Co. How Well Did AILs Treasury Do?

• International Finance
• Dick Sweeney

2
How Well Did AILs Treasury Do?

• From the case AIL had 200m worth of sales that
  were exposed to exchange risk last year. It
  hedged 40m of these. AILs treasury reports that
  on the 40m it hedged, it calculates it received
  payments of 40.075m. Had it not hedged, it
  calculates it would have received 39.288m. Thus,
  argues AILs treasury people, they made a profit
  of 0.787m or 787,000.

3
How Did AILs (cont.)

• Think of hedging in only one quarter of the year
  (simplifies analysis!)
• The treasury received 40.075m on the 40m by
  hedging. The forward premium is fp (decimal,
  quarterly).
• 40m (1 fp) 40.075m
• 1 fp 40.075 / 40 1.001817
• fp 0.001817 annualized 0.001817 x 4
  0.0075 in percent, 0.0075 x 100
• 0.75
• (not 1, the years average)

4
How Did AILs (cont.)

• Without hedge, would have received 39.288m.
• The euro appreciation rate, ?S/S, is found from
• 40m (1 ?S/S) 39.288m
• 1 ?S/S 39.288 / 40 0.9822
• ?S/S -0.0178 (decimal)
• ?S/S x 100 -1.78
• (percentage rate, but not annual rate)
• S fell 1.78 in this quarter, but only 2 over
  the entire year! Fell only 0.22 rest of
  year!
• Excellent time to hedge!

5
Assume zero depreciation in 1st quarter
-1.78 appreciation in 2nd quarter
1.00
Possible constant depreciation rate
-0.22 appreciation In last two quarters
0.98
Z
time
1
3
4
2
6
AILs Possible and Actual Losses from
Depreciation

• Possible Losses from Depreciation
• Total exposed amount over the year 200m
• Turnover of hedgeables 3 months
• Average exposure (per quarter) 50m
• Total depreciation -2.0
• Average depreciation per quarter -0.50
• Average loss per quarter 0.25m 50m x
  0.0050
• Total loss from depreciation 1.0m 4 x
  0.25m 50m x 0.02
• --------------------------------------------
  --------------------------------------------------
  --------------?
• time 0 3
  6 9
  12
• 50m
  50m 50m
  50m
• average ?S/S -0.50 ?S/S
  -0.50 ?S/S -0.50 ?S/S -0.50
• average 0.25m
  0.25m 0.25m
  0.25m
• loss
• total loss 1.00m

7
AILs Possible and Actual Losses from
Depreciation (cont.)

• Actual Losses from Depreciation
• Depreciation in second quarter -1.78
• Average depreciation in other quarters -0.073333
  - (2 - 1.78) / 3
  - 0.22 / 3
• Average loss in other quarters
  0.03666667m 50m x 0.000733333
• Total loss in other quarters 0.110m
• Saved by hedging in second quarter 0.89m x
  (40m/50m) .712m
• Actual loss in second quarter 0.178m 0.89m
  - 0.712m
• Total loss in all four quarters 0.288m
  0.110m 0.178m
• Actual loss / possible loss 0.288 0.288 /
  1.0m ? 28.8
• --------------------------------------------
  --------------------------------------------------
  --------------?
• time 0 3
  6 9
  12
• 50m
  50m 50m
  50m
• average ?S/S -0.0733 ?S/S -1.78
  ?S/S -0.0733 ?S/S -0.0733
• average 0.036667m 0.89m
  0.036667m 0.036667m
• loss
• total possible loss 1.0m
• total actual loss 0.288m