The Canadian Dollar Hedging
Price forward contract is hedging instrument are well known
and often used as a financial instrument. It has its advantages and
disadvantages both. The main disadvantage therein is the presence
of a shackle contract so that company can’t take the advantage of
favorable movements. It’s typically used when the company isn’t
interest with profit rather than hedging.
Different hedging strategies for Canadian dollars risk are used.
Our calculation is to reduce the total amount paid by General Motors
with respect 1.7 billion CAD cash to the suppliers. First we found
which is the most profitable hedging instrument on 50% hedge ratio
the we estimate the total cost paid in using 75% and 50% hedge
ratio.
We use the example data that given in case, we can estimate
the total cost should be paid by the company using 50% hedge
ratio. The graph shows that the options are more profitable at 1.6
exchange rate (1.6 is the rate where both lines crossing each other)
Opt
ions
Sp
Stri
ot
ke
Ra
Pri
tes
ce
1.5
1.4
667
1.5
1.5
667
1.5
1.6
667
1.5
1.7
667
1.5
1.8
667
Exe
Pre
rcis
miu
e
m
Yes
Yes
No
No
No
Actu
al
Gain/
Net
Pay
(Loss)
Payment
76001
14302264
28382
13397502
9255
ment
1428
1
9255
5714
1333
1
9255
3333
1250
1
9255
0000
1176
13284
-
1
9255
4706
1111
50049
-
1
1111
82729
-
12605835
11907306
11286391
Forwards
Futur
Hedge
Un-hedged
e
Forwar
Amount at
Amount at
Spot
d Rate
Forward
Future Spot
Rate
Rate
Rates
1.4
1.5667
6382843
7142857
1.5
1.5667
6382843
6666667
Now we can analyze
the income statement
gain/loss
scenarios
for
for
2
both
50% hedge ratio and
1.6
1.5667
6382843
6250000
1.7
1.5667
6382843
5882353
75% hedge ratio.
The level of loss and
1.8
1.5667
6382843
5555556
gain both are more in
50% hedge ratio as
compared to the hedge ratio of 75% and EPS also volatility is due to
a higher level of uncertainty involved in non hedged amount.
50% Hedge Ratio
Rates
1.627
1.529
Gain/Lo
EPS
ss
Change
44
-47
0.08
-0.09
75% Hedge Ratio
Rates
1.627
1.529
Gain/Lo
EPS
ss
Change
36
-36
0.07
-0.07
Translational risk is usually not hedged by the companies,
although if the impact is significant on the earnings of a company
then hedging it’s a secure option. Transaction risks should be
hedged if there’s high level of volatility in foreign exchange rates as
it’s in the case of Canadian.