Hedging Currency Exchange Risk

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Hedging Currency Exchange Risk
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Currency Exchange Risk
Cash Inflow in one Currency is Higher or Lower
than Corresponding Cash Outflow in Different
Currency Currency Exchange Rate Risk
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Types of Currency Exposure
Transaction exposure Occurs when contracts are
denominated in a foreign currency Translation
exposure Occurs when of financial statements
must be consolidated Operating (Economic)
exposure Occurs when the value of cash flows
depends on exchange rates
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Hedging Currency Exchange Risk
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• 2. Long Term Hedging
• Close Gap of Cash Flows in Different Currencies
• Direct Investment
• Finance Operation in Foreign Currency

Financial Instruments Can only Eliminate Short
Term Fluctuations, They Can NOT Eliminate the
Currency Exchange Rate Risk for Ongoing Business
Operations (operating exposure).
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Call Option Definition

• The right to buy at exercise price X
• Value of a call at expiration
• C Max ( 0, S - X)
• where
• C value of the call
• S spot price of currency
• X exercise price

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• Thus, if you own an option,
• you may win, but
• you will never lose
• Thats what you pay for when you buy the option
  (premium)
• Of course if your write (sell or go short) an
  option, thereafter you can only lose never win.

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Put Option Definition

• The right to sell at exercise price X
• Value of a put at expiration
• P Max( 0, X - S)