Hedging a EUR Exposure (Direct Hedge, Cross Hedge, Maturity Hedge) - Case Study Example

HEDGING A EUR EXPOSURE (DIRECT HEDGE, CROSS HEDGE, MATURITY HEDGE) By Date Forward Exchange ContractThis kind of currency transaction involves agreements between two exchange parties designated currencies at a specified time in future. After the spot contract settles it’s when these contracts takes place. They are mainly used with an aim of protecting a buyer from currency prices fluctuations. A percentage of a foreign currency which is hedged will in most cases be related directly to a foreign currency predictability in terms of cash flow.

The percentage of exposure increases as with rise in degree of predictability. As a hedge reaches maturity the next period automatically becomes hedged. Any party involved in hedges a percentage of its future experiences and then adds to future period hedges over time to raise the coverage percentage of in future periods.  Historically, of all types of hedges layered hedging offers the furthermost stable money exchange rates over time.Direct HedgeThe direct Hedge forward contract is expressed in percent, is calculated as follows; it is note able that all the exchange rates are expressed as amount of foreign currency for 1 unit of hedged currency.

 F_(today,t+90) = S_(today) * (1+rF) / (1+rF*).   The formula:T= the index calculation date S= Spot rate (St)R= Spot rate of the currency i two business days before the start of the currentCalculation ExampleThe following is a simple calculation of a two currency index hedged to GBP/EUR. And the calculations of the hedge for December 31, 2013. F (Dec 31st +90) = 341000 * (1+0.7355) / (1+0.6978)=(1.7355/1.6978)341000=1.022205*341000=348571Optimal hedge=1.022205D)Forward rate =Spot rate D) Scenario: 1F (March 31st +90) = 341000 * (1+0.6686) / (1+0.7355)Scenario 2 GBP/EURF (March 31st +90) = 341000 * (1+0.7005) / (1+0.7355)Scenario 3 GBP/EURF (March 31st +90) = 341000 * (1+0.7355) / (1+0.7355)Scenario 4 GBP/EURF (March 31st +90) = 341000 * (1+0.7742) / (1+0.7355)Scenario 5 GBP/EURF (March 31st +90) = 341000 * (1+0.8172) / (1+0.7355)Part 2: Gross hedgeThe following calculation of a two currency index hedged to JSP/ GBP.

And the calculations of the hedge for December 31, 2013. F (Dec 31st +90) = 341000 * (1+0.0044) / (1+0.0043)= (1.0044/1.0043)341000=1.0000995*341000=341033.95Optimal hedge=1.0000995B): Scenario 1 JSP/GBPF (March 31st +90) = 341000 * (1+0.6686) / (1+0.7355)Scenario 2 JSP/GBPF (March 31st +90) = 341000 * (1+0.7005) / (1+0.7355)Scenario 3 JSP/GBPF (March 31st +90) = 341000 * (1+0.7355) / (1+0.7355)Scenario 4 JSP/GBPF (March 31st +90) = 341000 * (1+0.7742) / (1+0.7355)Scenario 5 JSP/GBPF (March 31st +90) = 341000 * (1+0.8172) / (1+0.7355)Part 3.

  Maturity-Hedge:  The following is a simple calculation of a two currency index hedged to GBP/EUR. And the calculations of the hedge for a 6 months maturity rate starting from December 31, 2013. Calculation exampleF (Sep 30th +90) = 341000 * (1+0.6985/1+0.6754)=1.0021638*341000Optimal Hedge=1.0021638B) Scenario 1 GBP/EURF (March 31st +90) = 341000 *( (1+0.6686) / (1+0.7355)2)Scenario 2 GBP/EURF (March 31st +90) = 341000 *( (1+0.7005) / (1+0.7355)2)Scenario 3 GBP/EURF (March 31st +90) = 341000 * ((1+0.7355) / (1+0.7355)2)Scenario 4 GBP/EURF (March 31st +90) = 341000 * ((1+0.7742) / (1+0.7355)2)Scenario 5 GBP/EURF (March 31st +90) = 341000 * ((1+0.8172) / (1+0.7355)2)Reference ListDe Spiegeleer, J.

, Schoutens, W., & Jabre, P. (2011). The Handbook of Convertible Bonds Pricing, Strategies and Risk Management. Hoboken, John Wiley & Sons. http://www.123library.org/book_details/?id=18403.Erhemjamts, O., Raman, K., & Shahrur, H. (2010). Industry Structure and Corporate Debt Maturity. Financial Review. 45, 627-657