Case 2 Hedging Transaction Exposure Haowen Luo Peixin Zhang

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.

Measuring the TE Net Transaction Exposure (NTE) Spot rate = 0.009829 USD/JPY Net cash outflow = JPY 200,000,000 NTE= JPY 200M*0.009829 USD/JPY = USD 1.9658M

Range Estimates Ad-hoc Analysis USD 1,965,800 (1.10) = USD 2,162,380 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.

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(t+4) for each sample that we selected in previous step and calculate TE for each S(t+4) (iv) Plot the TEs in a histogram to construct simulated TE distrubution)

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 More

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.

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)

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.

Value at Risk (VaR) Input needed to calculate VaR Variance( adjusted to 4-month return) Variance= 4*0.001085 = 0.00434 CI=99% => zα=.01=2.33 Var(99%) = JPY 200M*0.009829 SD/JPY *sqrt(0.00434)*2.33 = = USD 301,745.02 => 4-month worst move is USD 301,745.02

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

Hedging using PHLX options Strategy ICF At Expiration ST<0.0098 ST>0.0098 Buy 200 PHLX DEC 0.0098 calls -119560 200M(ST-0.0098) Total 200M ST-2079560

Hedging using PHLX options Strategy ICF At Expiration ST<0.0098 ST>0.0098 Buy 200M OTC DEC 0.0098 calls -110420 200M(ST-0.0098) Total 200M ST-2070420

Options VS Forwad

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.

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 0.0098 p 0.00843 0.0100 p 0.10288 0.0096 0.00055 0.0098 0.00030 0.0100 0.00015

Three Months Forward  

Six Months Forward  

Six Months Forward  

Using Dec Futures Jun. St= 0.0098290 LONG FJun, Dec=0.009873 Nov. TIME SPOT FUTURES Jun. St= 0.0098290 LONG FJun, Dec=0.009873 Nov. SNov.= 0.008987 SHORT F Nov, Dec=0.008987 At delivery Actual purchase price: 0.009871  

Using the OTC JPY Option In the Money At November 17 St<0.0096 St>0.0096 Buy K=0.0096 Call Plus -1,797,000 Premium -131,240 Total cost 　-1.928,240

Using the OTC JPY Option At the Money At November 17 St<0.0098 St>0.0098 Buy K=0.0098 Call Plus -1,797,000 Premium -110,420 Total cost -1,907,420

Using JPY Dec Option Buy K=0.0096 Call At November Spot Market Premium -140,180 Offset Position 1,100 Total cost -1,936,080 Buy K=0.0098 Call -119,560 16,860 -1,899,700 Buy K=0.01 Call -101,160 300 -1,897,860

Left the Position Open  

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 K=0.0096 -1,899,700 K=0.0098 -1,897,860 K=0.01 No Hedge