Advanced FX Hedging Strategies (and what NOT to do): A Case Study

Given the extreme market volatility since the 2008 crisis, and the huge impact it can have on a multinational company's balance sheet and bottom line when it comes to foreign exchange exposures, what are the best options (pun, intended) for hedging volatility these days? From average rate options and baskets to partial barriers, compounds, and gated knock outs? What works, what doesn’t and why?

As we continue our Numerix webinar series on the best ways to manage your FX exposures, Udi Sela, Vice President of Client Solutions at Numerix, examines a renowned multinational US company with receivables in multiple currencies and an US Dollar-denominated cost base. 

In this case study, Mr. Sela specifically demonstrates a range of sophisticated FX option techniques, which can be used to hedge foreign currency exposures. Looking particularly at the Google business case—a dollar-denominated company with significant foreign-denominated exposure—Mr. Sela cites that, according to its December 2011 financial reports*, Google utilized FX options to hedge the following: USD $3.8 Billion vs. Euro; USD $2.2 Billion vs. British Pound and USD $0.5 Billion vs. Canadian Dollar.   (*Note: The option classes were not disclosed in the report.)

After listening to Mr. Sela’s comparative analysis examining the possible option strategies Google could have used—and exploring the initial cost, potential upside and worse case scenarios for these strategies—we come to see that it would make the most sense for a multi-national company like Google, with its ongoing receivables, to have used a combination of average rate, partial barrier forward and basket options to most effectively hedge its foreign exchange exposures.

We also observe that the Target Redemption Forward strategy could not be viewed as an effective hedge, since it would be way too risky. Mr. Sela wisely points out that this strategy is typically used by treasurers that ‘missed’ the company’s budgeted hedge rate.

View the webinar replay to learn more about the following FX hedging strategies: 

• Average Rate Option
• Partial Barrier Forward
• Compound Option
• Gated Knock Out
• Cross Asset Knock Out
• Basket Option
• Target Redemption Forward

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