PHA: Hedging Transaction Exposure for DW Inc.

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PHA Hedging Transaction Exposure for DW Inc.

• Marc Rosenthal
• Richard Cull
• James Frame
• Mehgan Haldane

2
Part I DWs Hedging Problem

• June
• DW orders parts valued at JPY 200,000,000
• Delivery in 2 months, payment within 30 days of
  delivery
• July 5th
• 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

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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

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Part I Hedging Strategies Proposed

• Forward Contracts
• PHLX Options
• Over-the-Counter-Options

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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 30th .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

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Part I Strategy Comparison Additional Data

• Exchange Rate Distribution
• Using Monthly Percent Change Data
• Created a Frequency Histogram
• Probability Distribution Observed
• St180 Probability
• USD .008678 9
• USD .009234 79
• USD .009863 12

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Part I Exchange Rate Distribution Histogram
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Part I Exchange Rate Distribution Histogram
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Exchange Rate DistributionSpot 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

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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

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OTC vs. PHLX Options
Potential Spot Price 180 Premium /unit Carrying Cost Exercise Option ? Total Price /unit Prob
.008678US .009234US .009863US OTC .0091 .000096 .000096 .000096 .000002745 .000002745 .000002745 NO YES YES .008776745 .009332745 .009961745 9 79 12
.008678US .009234US .009863US PHLX 96 .000042 .000042 .000042 .000001201 .000001201 .000001201 NO NO YES .008721201 .009277201 .009906201 9 79 12
.008678US .009234US .009863US PHLX 93 .000075 .000075 .000075 .000002145 .000002145 .000002145 NO NO YES .008755145 .009311145 .009940145 9 79 12
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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)

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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

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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

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Part II Comparisons

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

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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 5th (St,Jul) 0.009062
• Points on 3mo. Forward 0.000109
• Conversion Rate Paid USD/JPY 0.009171
• USD paid for parts (1,834,200)

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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 _at_ .009241 USD
  / JPY
• Nov 22th - Sold 6 month futures _at_ .008993 USD /
  JPY

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2) Had DW entered into the December futures
contract

• (Continued)
• Gain/(Loss) on Futures Contracts Contracts
  USD
• Long on July 5th (Ft, Jul) (0.009241)
  (16) (1,848,200)
• Sold on Nov 22nd (Ft, Nov) 0.008993
  16 1,798,600
• gt Loss on Futures (0.000248)
  (49,600)
• Loss Discounted Back 30 Days 49,600/(1
  .0565625 30/360) 233
• Bought JPY _at_ the Spot rate
• at Nov. 22th (St,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)

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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. 22nd (St,Nov)
  0.008973
• USD paid for parts (1,794,600)

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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 Price X 0.0091
• Premium Pt 0.000096
• Interest Rate (US) I 6.1875

St (Nov 22nd) Pt Exercise? Total USD Cost USD Paid for Parts
0.008973 0.000096 No 0.00927 1,854,000
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4) Had DW used the OTC JPY Option

• Carrying costs Pt interest rate
  (maturity/360)
• Carrying costs 0.000297
• If St is gt X, Do NOT Exercise

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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 Price X 0.0093
• Premium Pt 0.000075
• Interest Rate (US) I 6.1875

St (Nov 22nd) Pt Exercise? Total USD Cost USD Paid for Parts
0.008973 0.000075 No 0.009205 1,841,006
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5) Had DW used the JPY Dec. Options (PHLX)

• Carrying costs Pt interest rate
  (maturity/360)
• Carrying costs 0.000232
• If St is gt X, Do NOT Exercise

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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