Case 2 Hedging Transaction Exposure

1
Case 2 Hedging Transaction Exposure

• Haowen Luo
• Peixin Zhang

2
Story

• In June 2009, DW knows that it will have to pay
  JPY 200,000,000 for the Japanese parts in the
  future.
• Delivery expected to be in October 17, payment is
  due within 30 days of delivery, or before
  November 17.

3
Measuring the TE

• Net Transaction Exposure (NTE)
• Spot rate 0.009829 USD/JPY
• Net cash outflow JPY 200,000,000
• NTE JPY 200M0.009829 USD/JPY USD 1.9658M

4
Range Estimates

• Ad-hoc Analysis
• USD 1,965,800 (1.10) USD 2,162,380
• USD 1,965,800 (1-10) USD 1,856,108
• Therefore, estimated range for NTE is
• (USD 1,856,108 USD
  2,162,380)
• Note DW needs to have in the bank USD 2,162,380
  to cover the JPY outflow.

5
Range Estimates

• Sensitivity Analysis
• Simulation
• (i) convert monthly return to 4-month by
  using s(t) S(t)-S(t-4)/S(t-4)
• (ii) Randomly pick 50 samples(240
  observations) from empirical distribution
• (iii) Calculate S(t4) for each sample that
  we selected in previous step and calculate TE for
  each S(t4)
• (iv) Plot the TEs in a histogram to
  construct simulated TE distrubution)

6

Bin Frequency
0.009174 1
0.009292 5
0.009409 10
0.009526 12
0.009643 22
0.00976 36
0.009878 58
0.009995 27
0.010112 18
0.010229 26
0.010346 14
0.010464 3
0.010581 4
0.010698 2
0.010815 1
More 1
7
Range Estimates

• Based on the simulated distribution, we construct
  a 95 confidence interval. Therefore, the
  estimated range using simulation is
• (1,858,818
  2,096,489)
• Note DW needs to have in the bank USD 2,096,489
  to cover the JPY outflow.

8
Range Estimates

• Sensitivity Analysis
• Standard statistical theory
• Assumption
• Assume that 1-month exchange rate changes follow
  a normal distribution with mean of 0.0036 and
  monthly variance of 0.001085, where the man and
  variance are estimated using the past 39 years of
  monthly percentage changes. That is
• st N(0.0036 ,
  0.001085)

9
Range Estimates

• Sensitivity Analysis
• Standard statistical theory
• Based on the normal distribution, we construct a
  95 confidence interval. Therefore, the estimated
  range using simulation is
• (1,814,821
  2,173,736)
• Note DW needs to have in the bank USD 2,173,736
  to cover the JPY outflow.

10
Value at Risk (VaR)

• Input needed to calculate VaR
• Variance( adjusted to 4-month return)
• Variance 40.001085 0.00434
• CI99 gt za.012.33
• Var(99) JPY 200M0.009829 SD/JPY
  sqrt(0.00434)2.33
• USD 301,745.02
• gt 4-month worst move is USD 301,745.02

11
PHLX Options

• One option contract in PHLX covers 1,000,000 JPY.
  Therefore, in order to fully cover our position
  we need 200,000,000/1,000,000200 contracts.

12
Hedging using PHLX options
Strategy ICF At Expiration
STlt0.0098 STgt0.0098
Buy 200 PHLX DEC 0.0098 calls -119560 0 200M(ST-0.0098)
Total -119560 200M ST-2079560
13
Hedging using PHLX options
Strategy ICF At Expiration
STlt0.0098 STgt0.0098
Buy 200M OTC DEC 0.0098 calls -110420 0 200M(ST-0.0098)
Total -110420 200M ST-2070420
14
Options VS Forwad
15
Recommendation

• Based on our estimated TE, we would recommend to
  use the forward to hedge.
• It is more likely that the future spot rate will
  be lower than the strike price. When the future
  spot rate lower than the strike price, the
  forward strategy clearly dominate other two
  hedging strategies.

16
Story

• On November 6, the Japanese parts arrived on
  October 11 and payment is due in five days. The
  exchange rate is 0.008985 USD/JPY. The 1-mo. And
  3-mo. Forward USD/JPY rates are 0.0089845, and
  0.008985, respectively. U.S. Short interest rates
  for two months or less are 0.2909-0.3165. The CME
  Dec futures trades at 0.008987.The PHLX Dec
  options have the following prices (in U.S.
  cents)

JPY Dec. 0.0096 p 0.00668
JPY Dec. 0.0098 p 0.00843
JPY Dec. 0.0100 p 0.10288
JPY Dec. 0.0096 0.00055
JPY Dec. 0.0098 0.00030
JPY Dec. 0.0100 0.00015
17
Three Months Forward

•  

18
Six Months Forward

•  

19
Six Months Forward

•  

20
Using Dec Futures
TIME SPOT FUTURES FUTURES
Jun. St 0.0098290 LONG FJun, Dec0.009873 LONG FJun, Dec0.009873
Nov. SNov. 0.008987 SHORT F Nov, Dec0.008987 SHORT F Nov, Dec0.008987
At delivery At delivery At delivery At delivery
Actual purchase price Actual purchase price Actual purchase price 0.009871
 
21
Using the OTC JPY Option
In the Money At November 17 At November 17
In the Money Stlt0.0096 Stgt0.0096
Buy K0.0096 Call 0
Plus -1,797,000
Premium -131,240 -131,240
Total cost -1.928,240
22
Using the OTC JPY Option
At the Money At November 17 At November 17
At the Money Stlt0.0098 Stgt0.0098
Buy K0.0098 Call 0
Plus -1,797,000
Premium -110,420 -110,420
Total cost -1,907,420
23
Using JPY Dec Option
Buy K0.0096 Call At November
Spot Market
Premium -140,180
Offset Position 1,100
Total cost -1,936,080

Buy K0.0098 Call At November
Spot Market
Premium -119,560
Offset Position 16,860
Total cost -1,899,700

Buy K0.01 Call At November
Spot Market
Premium -101,160
Offset Position 300
Total cost -1,897,860
24
Left the Position Open

•  

25
Summary
Hedging Strategy Effective Cost
Three Months Forward
Six Months Forward
Dec Futures
OTC JPY Option -1.928,240 In the money -1,907,420 At the money
JPY Dec Option -1,936,080 K0.0096 -1,899,700 K0.0098 -1,897,860 K0.01
No Hedge