I need your help learned friends: A global company with USD as a functional currency is disbursing funds in Euros, pounds and CAD as a equity advances for working capital to be repaid in these 3 base currencies. The repayment dates are not 100% certain. How can one calculate forex exposure and hw best to hedge under such scenarios?
I like this question. I have a general idea where to look for the answer in my old notes but I’ll just wait for Bchad to reply.
Bchad where are u friend?
you can do three payer currency swaps over the average life of the transaction. ramp up/down the notional depending on how much you want ot hedge at the given exchange rates.
Your exposure is really just the size of the liability in each currency translated back to dollars, assuming that is your base currency) at the current exchange rate. If you want to calculate risk, then use liability size times standard deviation, or whatever substitute for SD you prefer. As for not knowing when the liabilities come due, well, you just have to make a best guess and take it from there. I don’t know for sure how you’d do it, but presumably if you wanted to do it the academic way, you’d take the liability and then either discount it or premiate it by the interest rate differential (foreign currency int rate - domestic cur int rate) and figure it out from there. If it’s working capital, that might be overkill though. It’s a bit like hedging currency exposure with foreign equities… you can make a best guess about how much you’ll need to repatriate and hedge that amount, but the performance of equities is inherrently uncertain, so you should expect to be off by a certain amount. As for what instruments, you could do a spot transaction, a currency swap, a forward currency contract, or a future.