Hedging decisions usually boil down to a choice between options and forwards.
In the past, many treasurers would have automatically opted for the latter, where cash flows were certain – or at least highly probable – but there are a number of scenarios in which this assumption can be flawed.
Firstly, the corporate’s business may be correlated to the foreign currency being hedged, which is typically the case in emerging markets. If a company selling goods in Russia and hedging expected sales in RUB hit trouble, sales volumes would fall and the company could find itself over-hedged.
The hedging of an acquisition is not straightforward either. Even after shareholders agree to a deal, there may be regulatory approvals to obtain, which means a UK-based corporate paying for the acquired company in USD would be exposed to the risk of the dollar appreciating.
“In this scenario, hedging with a forward would be risky as the timing of the transaction is uncertain,” says Romain Camus, head of exotic options at Digital Vega.
“If the regulators did not approve the transaction, the company would be left with a forward without having the underlying economic exposure and could be exposed to significant losses.”
