PROSPECTIVE ANALYSIS

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PROSPECTIVE ANALYSIS OF EXCHANGE RATE IN THE
ASPECT OF HEDGING TRANSACTIONS
Marcin Jedrzejczyk
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INTERNATIONAL TRANSACTIONS
Exchange rate differences
FINANCIAL RISK
RISK AVOIDEMENT STRATEGIES
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FINANCE ENGINEERING
Risk the possibility of not getting to the
predicted goals (not achieving success)
HEDGING
The income made in the transaction should be
higher or the loss lower than without using
hedging security
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HEDGING
The activity which should lead to the security of
the company against the unexpected change in the
price of the financial instrument.
Therefore it is an activity that uses the futures
market transactions to limitate the risk
connected with unfavorable changes of the price
on the spot market.
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HEDGING IN CONTRACT APPROACH
HEDGING
TRADING
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HEDGING WITH FUTURE CONTRACTS
PROFITS
LOSSES
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THE BASE
The average difference between observed prices
quoted on the spot and financial futures market
b(t) the base S(t) exchange rate on the spot
market F(t) er on the financial futures market
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MAIN AIM
To find the correlation between the profits made
on exchange rate differences connected with the
change in prices on both markets (spot and
financial futures).
IMPORTANT NOTE
Theoretical situation may appear when the changes
on both markets are equal what implicates the
fact of total elimination of risk
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MAIN CLASSIFICATION OF HEDGING
Selling hedge short hedge Buying hedge long hedge
Decision making backgroung The party tends to sell the assets to the foreign investor within the long payment horizon using the exchange rate from the day of the future payment The investor tends to buy the assets from the foreign party within the long payment horizon using the exchange rate from the day of the future payment
Type of the risk avoidment The risk of the depreciation of the exchange rate The risk of the apreciation of the exchange rate
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CASE STUDY 1
Company value (Euro) 4 PLNE 1 4,5 PLNE 1 3,5 PLNE 1
1 mln
Profit (loss)
1,5 mln
Profit (loss)
0,5 mln
Profit (loss)
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CASE STUDY 1
Company value (Euro) 4 PLNE 1 4,5 PLNE 1 3,5 PLNE 1
1 mln 4 mln PLN 4,5 mln PLN 3,5 mln PLN
Profit (loss) zero (0,5 mln PLN) 0,5 mln PLN
1,5 mln
Profit (loss)
0,5 mln
Profit (loss)
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CASE STUDY 1
Company value (Euro) 4 PLNE 1 4,5 PLNE 1 3,5 PLNE 1
1 mln 4 mln PLN 4,5 mln PLN 3,5 mln PLN
Profit (loss) zero (0,5 mln PLN) 0,5 mln PLN
1,5 mln 6 mln PLN 6,75 mln PLN 5,25 mln PLN
Profit (loss) (2 mln PLN) (2,75 mln PLN) (1,25 mln PLN)
0,5 mln
Profit (loss)
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CASE STUDY 1
Company value (Euro) 4 PLNE 1 4,5 PLNE 1 3,5 PLNE 1
1 mln 4 mln PLN 4,5 mln PLN 3,5 mln PLN
Profit (loss) zero (0,5 mln PLN) 0,5 mln PLN
1,5 mln 6 mln PLN 6,75 mln PLN 5,25 mln PLN
Profit (loss) (2 mln PLN) (2,75 mln PLN) (1,25 mln PLN)
0,5 mln 2 mln PLN 2,25 mln PLN 1,75 mln PLN
Profit (loss) 2 mln PLN 1,75 mln PLN 2,25 mln PLN
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CASE STUDY 2
On the 7th of March 2006 the company received
40.000 euro from the French parntner as the
payment of previously recorded receivables.
Exchange rate at that day accounted for 3,7884
zl/euro. This day the company has set the forward
transaction in which it has agreed to sell 40.000
euro on the 13 march using exchange of 3,8410
zl/euro. On the 9th March 2006 r. has sold the
currency with 3,8926 zl/euro. Receivables and the
contract are registered separately.
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• In the General Journal of the comapny the entity
  shuold account for
• The constitution of the contract forward for the
  amount - 153.640 zl (40.000 euro x 3,8410
  zl/euro)
• Dr Accounts receivable from the contract,
• Cr Accounts payable from the contract.

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The contract has been closed on 13th of March
2006 on the basis of the exchange rate 3,9480
zl/euro. So the difference on the contract is
In the accounting record it has to be reflected
by the following postings 1. The collection of
the amount due to the forward contract - 4.280 zl
(3,8410 zl/euro- 3,9480 zl/euro) x 40.000
euro Dr Financial cost, Cr Cash 2. Closing
of the contract - 153.640 zl Dr Accounts payable
from the contract, Cr Accounts receivable from
the contract..
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CASE STUDY 3
Polish company sells the goods at 1st December
2002 for the amount 10000 to the investor from
the USA. The current exchange rate 3,50 PLN1.
Date Amount Debit Credit
1/12/08 35000 PLN Accounts receivable () Sales
To avoid the risk connected with the receivables
made on the transaction, the company signs the
sales of 10000 in 90 days period. If the
financial futures price (90 days) accounts for
3,40 PLN1, then the company agrees to transfer
to the bank for 34000 PLN The difference
constitutes the future income, so it is to be
recorded as the discount.
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Date Amount Debit Credit
1/12/08 34000 PLN 1000 PLN 35000 PLN Accounts receivable from the future contract Discount (future cost) Accounts payable from the contract (to pay in )
If the current exchange rate at the end of the
year 2008 (spot rate) achieves 3,45 PLN1, then
the accounts receivable and payable will account
for 34500 (100003,45) what results in the
following posting
Date Amount Debit Credit
31/12/08 500 PLN 500 PLN Currency loss Accounts receivable from the contract Accounts payable from the contract Currency income
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It is clearly visible that currency incomes and
losses are leveling themselves. After one month
period the part of the discount constitutes the
cost. Thus
Date Amount Debit Credit
31/12/08 344 PLN Financial cost of the collateral Discount
At 1st March 2009 the payment becomes due for the
accounts receivable and the contract. If the rate
of exchange accounts for 3,30PLN1, the value of
10000 was equal to 33000 PLN. Thus the postings
require to be written as follows
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Date Amount Debit Credit
1/03/09 500 PLN 500 PLN 1000 PLN 1000 PLN Accounts receivable from the contract Currency loss Currency loss Accounts payable from the contract Currency income Accounts payable from the contract Accounts receivable from the contract Currency income
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Cash collection from the investor from the USA
Date Amount Debit Credit
1/03/09 33000 PLN Cash Accounts receivable
The payment of 10000 to the bank as an
implication of the contract
Date Amount Debit Credit
1/03/09 33000 PLN Accounts payable from the contract Cash
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Inflows connected with the contract
Date Amount Debit Credit
1/03/09 34000 PLN Cash Accounts receivable from the contract
Closing of the contract (zero out the contract)
Date Amount Debit Credit
01/03/09 2000 PLN Accounts payable from the contract Accounts Receivable
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Whats more the discount must be recorded as the
cost of the interest
Date Amount Debit Credit
01/03/09 656 PLN Financial cost of the collateral Discount
Despite quite remarkable changes in the exchange
rate in 90 days period the company held only 1000
PLN cost of the collateral. All profits and
losses balance themselves. The company have
received 24000 PLN as signed in the contract.
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EXCHANGE RATE THEORY
To understand the exchange rate we have to
understand the essence of money unit. This is
the wage productivity that has the basic
influence on the exchange rate recorded between
two countries (Dobija 2003)
Money is wage receivable
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EXCHANGE RATE IN YEARS 1993-2003 PLN
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LABOUR AND MONEY

• A basic formula describes labour (L) as product
  of acting force (F) and the distance, or path,
  (s) along which a body was shifted. Thus
• L F ? s F ? v ? t P ? t, where v
  velocity, t time , P - power
• Therefore labour is seen as an product of power
  and time
• kWh kW kilowatts ? ?t hours
• 5 kWh 500 Watt ? 10 hours

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LABOUR AND MONEY

• Cost of labour Coefficient of power Time of
  labour
• Cost of labour labour units Productivity of
  labourer Time hours
• 6 labour unit 3/5 10 hours

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WP RATIO
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EXCHANGE RATE THEORY
Using the presented theory of money and money
unit to the explanation of the changes of the
exchange rate, the labour productivity issue
observed in two countries must be considered and
implemented to the exchage rate cathegory.
The exemplification may focus on the economic
systems of Poland and the USA. If we assume that
the systems are almost equally productive, we can
formulate the equation
Q value of manufactured product, N average
amount of money paid for the labour unit, AP
average wage, ER exchange rate
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EXCHANGE RATE THEORY
In practice the equal economic systems happen
very rarely so we have to add the coefficient U
to equalise both economic systems
Where U is treated as the quotient of Polish and
American GNP quoted in USD per one worker. Using
GNP per worker we can formulate the comparison of
the labour cost in both countries
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EXCHANGE RATE THEORY
Thus
The comparative analisys considering two
countries without using coefficient U is useless.
The relationships between the inflation rate and
productivity determine the price of one currency
to the another. So
PDPP/USA the inflation parity measured with the
GNP deflator, WPPP/USA the work productivity
parity.
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EXCHANGE RATE THEORY
So we can formulate the conclusion that the right
form of PPP can be written as follows
RWP the real work productivity abroad, RWP
the real domestic work productivity, ER0 the
latest recorded exchange rate.
So this is not the labour cost relationships in
two countries that decide about the exchange rate
but the relationships between work productivity
of this countries.
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EXCHANGE RATE THEORY
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EXCHANGE RATE THEORY
Taking into regard an infite time horizon we can
write
Assuming the equal annual changes in the
productivity
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EXCHANGE RATE THEORY
THIS IS THE WORK PRODUCTIVITY WHICH MAINLY
DETERMINES THE CHANGES IN THE EXCHANGE RATE
BETWEEN TWO COUNTRIES
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ESTIMATION OF THE EXCHANGE RATE
To the approximation the method of the direct
estimation was choosen
Rn(tn) the estimator used to find the yn1
value (in this case it is conditioned suspected
value), hi(tn) cumulated value of the density
function for the parameters of the time
trend, hn1(tn) cumulated value of the density
function for the considered parameter.
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Period t t tsr (t tsr)2 hi(tn) yi yi hi(tn)
I 2000 1 6,5 42,25 0,0000 4,1181 0,0000
II 2000 2 5,5 30,25 0,0000 4,3860 0,0000
III 2000 3 4,5 20,25 0,0000 4,3957 0,0000
IV 2000 4 3,5 12,25 0,0000 4,5137 0,0000
I 2001 5 2,5 6,25 0,0000 4,0830 0,0000
II 2001 6 1,5 2,25 0,0000 3,9985 0,0000
III 2001 7 0,5 0,25 0,0000 4,2345 0,0000
IV 2001 8 0,5 0,25 0,0000 4,0785 0,0001
I 2002 9 1,5 2,25 0,0007 4,1270 0,0027
II 2002 10 2,5 6,25 0,0109 4,0583 0,0442
III 2002 11 3,5 12,25 0,0805 4,1499 0,3343
IV 2002 12 4,5 20,25 0,2674 3,9944 1,0682
I 2003 13 5,5 30,25 0,3989 3,8314 1,5285
II 2003 14 6,5 42,25 0,2674 y14  
SUM 105   227,5 1,0259   2,9780
AVERAGE 7,5   16,25      
    1,25      
    1,1180      
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ESTIMATION OF THE EXCHANGE RATE
PLN/