Cross Currency Hedging
First off not sure if this belongs here, but I wasn't sure where else to put it.
I am having some difficulties at work. I work on a small team of traders and we are otc market makers in spot fx. I will explain my issues through an example.
We are trading with customers/clients all day and have net exposure. At some point during the day we decide we don't want this exposure or want to lessen the risk by reducing the positions. I understand that concept of cross currency hedging and that if we are long AUD and Short JPY it makes sense to work with that pair instead of trading AUD/USD and USD/JPY. What I am looking for is some concrete ways to identify a cost efficient hedge and when to unwind that hedge. Any help is appreciated.
Not sure how you can be a ccy mkt maker and not know how to mitigate your currency risk...
Anyway, you would calculate your net exposure to each CCY ie calculate USD, AUD, JPY, EUR etc you have on your books. You can then try to boil it down to your core positions.
This, however, has nothing to do with your hedging strategies. For example, yeah sure you could end up realising you have a GBPSEK position. Awesome, how do you hedge it, trading GBPSEK? Probably not, likely the most efficient way to hedge it with direct market interaction is to trade EURGBP and EURSEK.
The most cost effective way is to deal in the most liquid pairs that make up the cross. Forgive me for being snide but it is hard to believe you have worked on a spot desk for longer than 2 days without learning this.
The reason I don't know this is because where I work they do it by customers. So if a customer trades shitty they don't hedge them or only hedge a portion. If a customer is a "good" trader they hedge them. Believe me I have been beating my head against the wall trying to figure out why, but that's the way they do it.
so far we do look at our net exposure to each instrument and then say whoa that's big position and only will offset it because its a big position and we don't want that risk. WE DON'T LOOK AT ANYTHING ELSE. Which is fucking asinine. So if I have all these net positions and I want to eliminate the risk on a cross pair, I buy or sell the pair. I get that, but what is holding the desk back from doing this instead of shifting customer accounts is that they don't know how to unwind the hedges or when to? I haven't been at the job long and took it thinking that I would learning all the stuff I SHOULD be learning. Turns out I only get a portion of that experience. Any reading or resources are greatly appreciated, because I am short of resources obviously.
How to Structure currency hedge for LBO? (Originally Posted: 04/04/2012)
Hey guys,
I'm a grad student working on a case that involves an American equity firm about to invest in a Canadian firm. Basically we are to devise a currency hedge by investigating the different options out there: (e.g. forward, options and collars)
Parameters: LBO Total Value: $51.7B CAD Equity to Raise: $40.0B CAD Investment Horizon: 5 yrs IRR: 25% total d/e expectation: 90%/10%
Spot Rate: 1.045CAD/USD Forward: 1.027CAD/USD Put Premium: 1.53% of the amount hedged, specifically for a put at $1.10 (out of the money)
I am just not clear about a few things... - the IRR was an assumption provided that stated (per annum) but 25% per annum seems rather high. Is it typically that the 25% is at the end of the project? - the parameters have been given pretty much so why do they ask us to decide how long to hedge and how much?
thanks so much! I don't have a strong finance background so coming up to speed on these types of problems are difficult for me. Even if you could point me in the direction of some good resources that'd be great!
I have been reading up on LBOs and structuring but nothing came up specific to these types of problems.
25% IRR is typically the low end of the range for an LBO. You won't see many buyers pursue something that wont return an IRR of 25% (and yes, that is per annum).
I'm not sure I understand the complexity of this case, but it seems pretty straightforward. A PE firm is investing 10% of the total enterprise value. with an IRR of 25% you can calculate how much equity the PE firm can expect to receive in 5 years. and assuming the forward rate is a 5yr rate (same for puts) then this is pretty straightforward. you are missing quite a bit of detail though so I can't give a direct answer without knowing more.
do your own home work. its d only way to learn. calculate the equity return per yr. calculate the forward rate to (1+f5). multiply and thats it.
How to hedge currency risk on foreign stocks (Originally Posted: 01/01/2014)
I am based in the UK and interested in a few shares based in the USA and Europe. However, I am concerned about currency risk.
What is the correct way to hedge against it and also the cheapest way?
Cheers
Forex options
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