Commodity Input and Resulting Currency Risk

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 risks due to commodity costs and currencies. What is new here is that the underlying commodity is priced and traded in a currency that is different from the reporting currency of our company.

BACKGROUND

Mocha is a EUR-reporting company that buys Arabica coffee in the world markets. The benchmark coffee contract, Coffee “C”, is priced in USD. This contract11 For more details, see https://www.theice.com/products/15/Coffee-C-Futures. fixes a future price for physical delivery of exchange-grade green beans from one of 19 countries of origin in a licenced warehouse to one of several ports in the US and Europe. There are five maturity dates: March, May, July, September and December, from which we can interpolate the value of the contract for any maturity from one to 12 months. For example, the history of a 12-month interpolated C contract is shown in Figure 38.1. The contract is priced in USD/lb and the size of the contract is 37,500 lbs.

As we can see, coffee is a volatile commodity. Its annual volatility of returns is 32%. The procurement department of Mocha is mandated to reduce this volatility, which is normally done via C

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