Giddy | Hedging 1
Hedging Techniques
Dr. Ian Giddy
New York University
Techniques of Hedging
A brief comparison of hedging tools
Forwards, futures, swaps
Asset-liability matching
Pricing and linkages among the tools
Uses and abuses of options
When to use, and when not to use
Copyright ©2009 Ian H Giddy
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Giddy | Hedging 2
What Hedging Instruments?
What Protection Needed?
Volatility & Complex risks
Direction
Direction Or arbitrage
OTC options, Forwards, Exotics, Hybrids,
Futures, structured
Caps and Floors Swaps notes
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Tools for Hedging
Petrobras has to pay for equipment from Japan, in
Japanese yen, in 3 months
Borrow and pay now?
Use a forward contract/FX swap?
Pay later at spot?
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Giddy | Hedging 3
Forward Contracts, Futures
and Money Market Hedging
Money market hedging: match currency of assets
and liabilities
Forwards: Agreement to exchange currencies at
certain exchange rate in the future
Futures: Exchange-traded contracts for notional
future delivery, minimizing default risk via marking-to-
market
Currency swap: match payments on foreign-currency
debt
Interest-rate swap: change floating cost to fixed
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A Typical Forward Exchange Contract
We agree today to pay a certain price for a currency in
the future
JPY
Sony
Sony BBof
ofAA
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Giddy | Hedging 4
Forward Quotations
Source: ft.com
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The FX Swap Hedge
3-month Swap
3-month Forward Contract
l Dealers typically hedge a forward foreign-exchange
commitment with a spot plus “FX Swap”: spot sale
plus forward purchase of a foreign currency
l The FX swap rate is determined by the interest
differential
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Giddy | Hedging 5
The Roll-
Roll-Over Swap Hedge
3-month Swap 3-month Swap
6-month Forward Contract
l Dealers often hedge a long-term foreign-exchange
commitment with shorter-term contracts, which are
“rolled over” as they come due
l Corporations themselves do this too.
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Futures – Like Forwards, But Traded on an Exchange
Source: quotes.ino.com
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Giddy | Hedging 6
A Currency Swap: Used to Hedge Debt
IDR 100,000
Indosat
Indosat BANK
BANK
USD 10 USD 10
Indosat issues dollar debt, but wants rupiah financing
so exchanges its dollars for IDR equivalent
at today’s spot exchange rate
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Periodic Exchange of Interest
IDR 100,000
Indosat
Indosat BANK
BANK
USD 10
Fixed IDR 12%
Indosat
Indosat BANK
BANK
Floating USD
3-mo Libor
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Giddy | Hedging 7
Three Parts of a Currency Swap
IDR 100,000
Indosat
Indosat BANK
BANK
USD 10
Fixed IDR 12%
Indosat
Indosat BANK
BANK
Floating USD
Libor
IDR 100,000
Indosat
Indosat BANK
BANK
USD 10
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Interest Rate Swap
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Giddy | Hedging 8
Swap Quotations
Source: ft.com
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Managing Exchange Risk:
Tools & Techniques
Borrowing
Lending
Symmetrical contracts Kinky contracts
Forward contracts OTC options
Futures Exchange-traded
options
Swaps Exotics
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Giddy | Hedging 9
Spot, Forwards and Swaps in Indonesia
Forward and swap
transactions are
necessary for hedging
But they are declining
as a percentage of the
total in Indonesia
Source: Bank Indonesia Annual Report 2007
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“Cost of Hedging”
Hedging” is Neutral
Type of Hedge Cost of Hedging
Forward Forward premium
Money Market Hedge Interest rate
(Borrow to match differential
assets)
Do nothing Expected rate of
change of
exchange rate
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Giddy | Hedging 10
When Should We Use Options to Hedge?
Petrobras hedging cost of Japanese debt
FORWARD
CONTRACT
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When Should We Use Options to Hedge?
Petrobras hedging cost of Japanese debt CALL
OPTION
ON YEN
FORWARD
CONTRACT
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Giddy | Hedging 11
Option Hedges
Questions about options:
- When should companies use them?
- Which options?
- How much do they cost?
- Are they worth paying for?
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Hockey Sticks
CALL PUT
BUY
SELL
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Giddy | Hedging 12
View on Direction, Volatility or Both?
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The Hedging Choices
“Natural”
“Natural”
Hedge?
Hedge?
or
Derivatives?
Derivatives? Debt?
Debt?
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Giddy | Hedging 13
A Hedging Roadmap
Motivations for Hedge
Driven by Driven by company
company views needs
Volatility: options, Company has Company has
Direction: economic natural
forwards, debt exposure hedge
Market risk Forwards,
No need for hedging
remains swaps or debt
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Contact
Prof. Ian Giddy
NYU Stern School of Business
Tel +1.646.8080.746; Fax +1.866.369.9350
[email protected] Web: giddy.org
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