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 = USD/JPY
Net cash outflow = JPY 200,000,000
NTE= JPY 200M* USD/JPY = USD M

4. 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.

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(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)

6. Bin
Frequency 1 5 10 12 22 36 58 27 18 26 14 3 4 2
More

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 and monthly variance of , where the man and variance are estimated using the past 39 years of monthly percentage changes. That is
st ~ N( , )

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, $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= 4* =
CI=99% => zα=.01=2.33
Var(99%) = JPY 200M* SD/JPY *sqrt( )*2.33 =
= USD 301,745.02
=> 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 200,000,000/1,000,000=200 contracts.

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

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

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 USD/JPY. The 1-mo. And 3-mo. Forward USD/JPY rates are , and , respectively. U.S. Short interest rates for two months or less are The CME Dec futures trades at The PHLX Dec options have the following prices (in U.S. cents):
JPY
Dec. p p p
0.0096
0.0098
0.0100

17. Three Months Forward

18. Six Months Forward

19. Six Months Forward

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

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

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

23. 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= Call
-119,560
16,860
-1,899,700
Buy K=0.01 Call
-101,160
300
-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 K=0.0096
-1,899,700 K=0.0098
-1,897,860 K=0.01
No Hedge