This content explains how to manage foreign exchange (FX) risk by comparing two external hedging methods: forward contracts and money market hedges, demonstrating that a money market hedge can be more cost-effective.
Mind Map
คลิกเพื่อขยาย
คลิกเพื่อสำรวจ Mind Map แบบอินเตอร์แอคทีฟฉบับเต็ม
Remember,
we're still looking at how to manage FX
risk and we've said there are several
methods to use both internal and
external method. Internal method you can
issue in local currency. You can do
matching and netting.
You can as well do lead payment.
external method. We said you can use
forward transactions, you can use
futures, you can use money market edge
swaps, both forex swaps and currency
swaps, you can use options as well. Now
I'm looking at a question to practice
some of those methods and this question
if you pause the video take one minute
to go through the question. This
question requires you to apply three
methods. The first one is the netting.
The second one requires the knowledge of
forward contracts and the third one is
the knowledge of money market edge. So
but the requirement want us to decide
whether the company should use a forward
or should use a money market edge.
Remember both forward and money market
edge edges are actually external
methods. But if you see this question
and you realize that you have to do
matching first because there's an
application of internal method that you
can use and this is due to the fact that
there is
an account payable of 240,000
due in 3 months and there's account
receivable of the same currency of about $69,000
$69,000
due at in this at the same time. Yeah.
So in that case you can do the initial
internal method which is matching or
netting in this case because the
external part is involved. So you can
call it matching. Yeah. So you have
171,000 net. So this is the net account
payable that you need to look for
And for us to decide whether the company
should use forward contract or money
market edge,
this will be based on our attempt to
edge $171,000
and not $240.
So this is the amount that we need to
edge because this is what we need to pay
net in 3 months that we don't have.
How do we go about this? Let's check how
much this will equivalent to in our
local currency. If we use forward contract
contract
remember contract about you fixing the
feature rate at which we do a contract.
We need to know our exposure first of
all and we know that our exposure is
that we need to buy $171,000
That is what we want to achieve. So if
we want to use forward it means that we
need to buy forward for 3 months. So and
we've been given the quote for 3 months
forward here as you can see it for
dollar and euro as to this. But the
question is which rate are we using? Is
it a buy rate or is it a sell rate? And
remember the clue that I always tell
you, you must always interpret your
quotes in bank perspective and second
currency perspective. Which means you're
asking yourself what is the bank going
to do to the second currency. What is
the second currency here is the base
currency which is the currency at the
back that's one in one unit and here is
euro. Yeah, because what the quote is
saying is that bank will buy 0.9520
for 10 and will sell one for sorry let
me start again bank will buy 10 for 0.9520
0.9520
if the company needs to buy $171,000.
What does that mean for the bank in
terms of euro? Let's go through the
thought process. If the company wants to
buy $171,
it means that the company will have to
sell pounds to be able to buy that
dollar. So now, sorry, we have to sell
euro and good enough euro is our second
currency. So we get that understanding,
right? So the company is selling euro
and if company is selling euro, they
must be selling to the bank. then that
means the bank is buying the euro and in
that case we able to interpret from the
bank perspective and from euro
perspective. So if bank is buying euro
definitely the applicable rate that will
be used will be 0 9520
which is the buying rate so which means
this US dollar is equivalent to 1.
US to hedge and that will mean we need
to buy we need to sell the company. We
have to sell this amount of euro to be
able to buy this amount of dollars from
the bank. So which means the amount that
we need in local currency is 171 179
179
6 to1
in order for us to use forward. But
let's see what money market edge has for us.
us.
Remember the few steps I always tell you
to use for money market edge so that you
don't get confused and feel like it is
complicated. It is not complicated. The
first one is always to understand the
company's situation which is the
exposure. Yeah. And this come around the
That is the problem that we have.
Then we need to create a money market
objective to manage that problem. So
since we know that this is a liability
that we have
remember the money market objective is
always the opposite.
What does it mean? It means that we need
to create an asset that will be exactly $171
$171
in 3 months. So we're saying we need to
create an asset
now that will have value equal
equal to
to 171k
171k
So that is the opposite thing that we
need to do. We need to create that asset.
That is that is our objective. That is
what we want to achieve this objective.
This is the money market objective.
Okay. Now since we know the money market objective,
