How to Hedge High Carry Currencies

Stanley Myint and Fabrice Famery

Contents

Foreword

Introduction

1.

Theory and Practice of Corporate Risk Management

2.

Theory and Practice of Optimal Capital Structure

3.

Introduction to Funding and Capital Structure

4.

How to Obtain a Credit Rating

5.

Refinancing Risk and Optimal Debt Maturity

6.

Optimal Cash Position

7.

Optimal Leverage

8.

Introduction to Interest Rate and Inflation Risks

9.

How to Develop an Interest Rate Risk Management Policy

10.

How to Improve Your Fixed-Floating Mix and Duration

11.

Interest Rates: The Most Efficient Hedging Product

12.

Do You Need Inflation-linked Debt?

13.

Prehedging Interest Rate Risk

14.

Pension Fund Asset and Liability Management

15.

Introduction to Currency Risk

16.

How to Develop Currency Risk Management Policy

17.

Translation or Transaction: Netting Currency Risks

18.

Early Warning Signals

19.

How to Hedge High Carry Currencies

20.

Currency Risk on Covenants

21.

Optimal Currency Composition of Debt 1: Protect Book Value

22.

Optimal Currency Composition of Debt 2: Protect Leverage

23.

Cyclicality of Currencies and Use of Options to Manage Credit Utilisation

24.

Managing the Depegging Risk

25.

Currency Risk in Luxury Goods

26.

Introduction to Credit Risk

27.

Counterparty Risk Methodology

28.

Counterparty Risk Protection

29.

Optimal Deposit Composition

30.

Prehedging Credit Risk

31.

xVA Optimisation

32.

Introduction to M&A-related Risks

33.

Risk Management for M&A

34.

Deal-contingent Hedging

35.

Introduction to Commodity Risk

36.

Managing Commodity-linked Revenues and Currency Risk

37.

Managing Commodity-linked Costs and Currency Risk

38.

Commodity Input and Resulting Currency Risk

39.

Offsetting Carbon Emissions

40.

Introduction to Equity Risk

41.

Hedging Dilution Risk

42.

Hedging Deferred Compensation

43.

Stake-building

In this chapter, we continue the discussion of currency risk from EM currencies, while focusing on the high carry currencies – ie, those currencies with a high interest rate differential to G10 currencies. The topic of high carry has already been touched upon in Chapters 16 and 18, and it is important for many companies. Before we get into possible solutions, we should explain why this is the case.

We can broadly classify hedging costs in three categories: transaction cost; direct cost of administering the hedging program, and potential loss due to derivatives (counterparty loss, financial loss from the misuse of derivatives, reputational loss, etc.). However, cost of carry is nowhere in this list. So why do we call it a “cost” and why is it particularly important for high carry currencies? Let us take an example of the USDBRL exchange rate and how it impacts an exporter from USD to BRL. As of the time of writing, the spot exchange rate is 3.51 and one-year forward is 3.61.11 Source: BNP Paribas, May 1, 2018. Therefore, the level for forward exchange is 2.8% higher than the spot. However, 2.8% is just the relative difference in market levels at which the BRL proceeds can be

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