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Karim Alidina
Rotman MBA 2007
karim.alidina07@rotman.utoronto.ca
The views and recommendations in this presentation do not represent the views of RBC Capital Markets and are solely of the author.
What is FX Risk?
A Canadian Corporation buys USD 1mm out one year using a forward contract
A USD/CAD spot range of 0.8644 – 1.1507 represents the potential spot movements over
one year.
1.1200
1.0200 Achievable
CAD 0.87 mm
1.0000 Value
0.9700
95% Worst
CAD 1.15 mm
0.9200 Case
0.8700 VaR USD 131,000
0.8200 0.8644
13-May-11
29-Nov-11
16-Jun-12
02-Jan-13
21-Jul-13
06-Feb-14
Canadian Dollar Spot
Why do Corporations Manage FX Risk?
Identification of exposure:
¾Determine whether you need to hedge
Determine FX levels:
¾Budget rate
¾Target rate
Execute FX hedge when target reached
¾Use appropriate hedging instrument
Example
Assumptions:
Canadian Corporate needs to purchase USD
Exposure:
¾USD 1mm notional
¾Term: 1 year
Budget rate: 1.0000
Strategy:
Client enters into one year forward contract to buy USD 1mm at an all-in
rate of 1.0000.
What Can Prevent Best Practice?
Result:
Execution rate is often at or below the target rate
Hedging Strategies
Limitations:
Corporations tend to only use certain products
¾Product knowledge
¾Board decision
Only some Corporations use FX options
Purchased options are useful if there is doubt whether a foreign exchange
transaction will be necessary
Result:
Corporations cannot participate in favourable currency moves
Hedge Accounting
Limitations:
Reduced potential use of various option strategies
Result:
Corporations cannot fully participate in favourable currency moves
Example
Assumptions:
Canadian Corporate needs to purchase USD
Exposure:
¾USD 1mm notional
¾Term: 1 year
Budget rate: 1.0000
Strategies:
Client enters into one year Forward Contract to buy USD 1mm at an all-in
rate of 1.0000.
Client purchases a one year USD Call for CAD 41,000 (410 CAD pips)
Client enters into a one year Costless Collar to buy USD 1mm, with
protection level at 1.0500 and benefit level at 0.9700.
Client enters into a one year Cablecar Forward Contract to buy USD 1mm
at a rate of 1.0100 with a knock-in barrier at 0.9200.
Hedging Strategies
Setting target rates can help a Corporation decide when to use forwards
versus other option strategies:
¾Take profit versus stop-loss level management
¾The Corporation can use forward contracts to buy USD when the CAD is
strong and it is beneficial to lock in gains
¾The Corporation can use other hedging strategies to buy USD when CAD
is weak which allows them to benefit from CAD appreciation
Use various hedging strategies to express views, manage forecast errors
and to avoid forward contract losses
¾Diversify a corporation’s hedging portfolio
MTM variations on income statements should be accounted for in the
valuation of a company by the analyst
¾The Corporation should not be limited in their hedging strategy
Questions