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PHA PHA: Hedging Transaction Exposure for DW Inc. Marc Rosenthal Richard Cull James Frame Mehgan Haldane.

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Presentation on theme: "PHA PHA: Hedging Transaction Exposure for DW Inc. Marc Rosenthal Richard Cull James Frame Mehgan Haldane."— Presentation transcript:

1 PHA PHA: Hedging Transaction Exposure for DW Inc. Marc Rosenthal Richard Cull James Frame Mehgan Haldane

2 Part I: DW’s Hedging Problem June DW orders parts valued at JPY 200,000,000 Delivery in 2 months, payment within 30 days of delivery July 5 th Confirmation of delivery in October Expected delivery is Oct. 28th

3 Part I: Range Estimates of Transaction Exposure: Data Monthly JPY/USD Exchange Rate Data: 1/31/71 – 8/31/01 367 Observations Monthly Exchange Rate Percentage Changes Descriptive Statistics Std. Deviation 0.033389951 Minimum -0.109192201 Maximum 0.147448569

4 Part I: Risk Analysis of Transaction Exposure Sensitivity Analysis Worst Case Scenario 200,000,000 JPY x.009062 x (1 +.147449) = $2,079,637 USD Best Case Scenario 200,000,000 JPY x.009062 x (1 -.109192) = $1,614,500 USD

5 Part I: Risk Analysis of Transaction Exposure Confidence Interval Based on Normal Distribution Upper Bound 200,000,000 JPY x.009062 x (1 +.065464) = $1,931,047 USD Lower Bound 200,000,000 JPY x.009062 x (1 -.065464) = $1,693,753 USD

6 Part I: Hedging Strategies Proposed Forward Contracts PHLX Options Over-the-Counter-Options

7 Part I: Hedging Instruments : Data Spot Price (USD/JPY).009062 Forward Contracts 6 Month Forward Points:.000238 PHLX Options-Dec Calls Contract: P.0042 cents/unit Strike Price.0096 Contract: P.0075 cents/unit Strike Price.0093 Over-the-Counter-Options Nov 30 th :.0096 cents/unit Strike Price.0091

8 Part I: Contract Size PHLX Call Option Contracts Needed 200,000,000 JPY / 6,250,000 = 32 Contracts OTC Call Options Needed: 1 Contract Forward Contracts Needed: 1 Contract

9 Part I: Strategy Comparison: Additional Data Exchange Rate Distribution Using Monthly Percent Change Data Created a Frequency Histogram Probability Distribution Observed: S t+180 Probability USD.008678 9 % USD.009234 79% USD.009863 12%

10 Part I: Exchange Rate Distribution Histogram

11

12 Exchange Rate Distribution Spot Rate Forecast Calculation -.08(2) + -.04(31) = -1.40 -1.40/33 = -4.24% 33/367 = 9%.009062 * (1-.0424) =.008678.00(153) +.04 (138) = 5.52 5.52/291 = 1.897% 291/367 = 79%.009062 * 1.01897 =.009234.08(35) +.12(7) +.16(1) = 3.80 3.80/43 = 8.84% 43/367 = 12%.009062 * 1.0884 =.009863

13 Option Carrying Cost Calculation OTC Call Option (.0091 Strike Price) Carrying Cost.000096 *.0571875 * 180/360 =.000002745 USD/unit PHLX Call Option (.0096 Strike Price) Carrying Cost.000042 *.0571875 * 180/360 =.000001201 USD/unit PHLX Call Option (.0093 Strike Price) Carrying Cost.000075 *.0571875 * 180/360 =.000002145 USD/unit

14 Potential Spot Price 180 Premium /unit Carrying Cost Exercise Option ? Total Price /unit Prob.008678US.009234US.009863US OTC.0091.000096.000002745 NO YES.008776745.009332745.009961745 9% 79% 12%.008678US.009234US.009863US PHLX 96.000042.000001201 NO YES.008721201.009277201.009906201 9% 79% 12%.008678US.009234US.009863US PHLX 93.000075.000002145 NO YES.008755145.009311145.009940145 9% 79% 12% OTC vs. PHLX Options

15 Part I: Instrument Comparison Forward Purchase JPY 6 Months 200 M JPY x (.000238 +.009062)= $1,860,000 USD OTC Option Strike Price.0091.008776745 * 200 MIL JPY = $1,755,349 USD.009332745 * 200 MIL JPY = $1,866,549 USD $1,866,549USD – $26,800 = $1,839,749 USD (Net).009961745 * 200 MIL JPY = $1,992,349 USD $1,992,349 USD – $152,600 = $1,839,749 USD (Net)

16 Part I: Instrument Comparison (Cont.) PHLX Option Strike Price.0096.008721201 * 200 MIL JPY = $1,744,240 USD.009277201 * 200 MIL JPY = $1,855,440 USD.009906201 * 200 MIL JPY = $1,981,240 USD $1,981,240 – $52,600 = $1,928,640 USD PHLX Option Strike Price.0093.008755145. * 200 MIL JPY = $1,751,029 USD.009311145. * 200 MIL JPY = $1,862,229 USD.009940145 * 200 MIL JPY = $1,988,029 USD $1,988,029 - $112,600 = $1,875,429 USD

17 Recommendation OTC Option Strike Price.0091.008776745 * 200 MIL JPY = $1,755,349 USD.009332745 * 200 MIL JPY = $1,866,549 USD $1,866,549USD – $26,800 = $1,839,749 USD (Net).009961745 * 200 MIL JPY = $1,992,349 USD $1,992,349 USD – $152,600 = $1,839,749 USD (Net) Recommend: Buy OTC Option with NOV Expiration

18 Part II:Comparisons November 22 Japanese parts arrived Oct. 27 th Payment due in 5 days Exchange rate:.008973 USD/JPY The cost to DW, Inc. will vary depending on the hedging approach undertaken…

19 1)Had DW entered into a 3 month forward contract DW would have taken a long position in the forward contract, to offset their short position Amount to be paid for parts JPY (200,000,000) Spot rate on July 5 th (S t,Jul ) 0.009062 Points on 3mo. Forward 0.000109 Conversion Rate Paid USD/JPY 0.009171 USD paid for parts (1,834,200)

20 2) Had DW entered into the December futures contract DW would have taken a long position in the futures contract, to offset their short position (on CME: contract = 12,500,000 Japanese Yen) July 5th - Bought 6 month futures @.009241 USD / JPY Nov 22th - Sold 6 month futures @.008993 USD / JPY

21 2) Had DW entered into the December futures contract (Continued) Gain/(Loss) on Futures ContractsContracts USD Long on July 5 th (F t, Jul ) (0.009241) (16)(1,848,200) Sold on Nov 22 nd (F t, Nov ) 0.008993 16 1,798,600 => Loss on Futures (0.000248) (49,600) Loss Discounted Back 30 Days 49,600/(1 +.0565625 * 30/360) 233 Bought JPY @ the Spot rate at Nov. 22th (S t,Nov ) 0.008973 Amount to be paid for parts JPY (200,000,000) (1,794,600) (1,794,600) USD paid for parts (1,843,967)

22 3) Had DW not hedged the payment DW would bought JPY at the prevailing Spot Rate when the payment was due. Amount to be paid for parts JPY (200,000,000) Spot rate at Nov. 22 nd (S t,Nov ) 0.008973 USD paid for parts (1,794,600)

23 4) Had DW used the OTC JPY Option DW would have bought a call option to cover payables Variables Amount (JPY)200,000,000 Strike PriceX0.0091 PremiumP t 0.000096 Interest Rate (US)I6.1875 S t (Nov 22nd) PtPt Exercise?Total USD Cost USD Paid for Parts 0.0089730.000096No0.009271,854,000

24 4) Had DW used the OTC JPY Option Carrying costs=P t * interest rate * (maturity/360) Carrying costs=0.000297 If S t is > X, Do NOT Exercise

25 5) Had DW used the JPY Dec. Options (PHLX) DW would have bought a call option to cover payables Same procedure as the OTC Options Variables Amount (JPY)200,000,000 Strike PriceX0.0093 PremiumP t 0.000075 Interest Rate (US)I6.1875 S t (Nov 22nd) PtPt Exercise?Total USD Cost USD Paid for Parts 0.0089730.000075No0.0092051,841,006

26 5) Had DW used the JPY Dec. Options (PHLX) Carrying costs=Pt * interest rate * (maturity/360) Carrying costs=0.000232 If S t is > X, Do NOT Exercise

27 Part II: Summary Scenario USD paid for parts 3 month Forward $1,834,200 Dec futures $1,844,200 No hedge Lowest OTC options Highest $1,854,000 PHLX options $1,841,006 $1,794,600

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