Forum Archive Index - June 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi trader 100,
 
> 
> 
>I take your point about the 'risk' of a hedge being out of the
>money.  Although from a finance point of view I believe that the
>correct way to look at a forward contract is to say that it has
>removed the risk but, as with any decision, there is an opportunity
>cost.
> 
>

Interestingly enough, I happened to hear financial commentator Murray 
Weatherstone's interview on National radio this morning where he was 
discussing exactly this topic.   The bit I hadn't appreciated before 
was that the rate set in a hedge contract is not a prediction of 
where the exchange rate will go.   It is just a balancing out of the 
interest rate risk, as you have explained to us 'trader 100'.

Weatherston also said that often the bank drawing up the exchange 
rate hedge asks for a 'deposit' on the future transaction, sometimes 
as high as 20% of the capital to be spent in one years time!  This 
seems outrageous.

It still seems odd to me that a New Zealand company would seek to 
mitigate their exchange rate risk by taking out a 'policy' which 
makes no pretence at guessing where the exchange rate is going!   
Because of this, I find it hard to come to terms with the idea that 
the New Zealand company is 'out of the money' if the exchange rate 
'goes the other way'.  I feel 'out in left field' would be a more apt 
description of such an event.  

I guess the main niggle I still have is that as an importer you want 
to make sure the $NZ doesn't go below a certain price.  As an 
exporter you want to make sure the $NZ doesn't go above a certain 
price.  Hedging is not really a protection against this, because it 
is not guaranteed that the hedging price you will be offered will 
meet these goals.  I wonder at the opportunity cost of taking out a 
'policy' that doesn't really cover the event you are trying to insure 
against.   Hedging seems to be a take it or leave it bet.  I was 
under the impression that *if* the exchange rate you were offered as 
a hedge did not meet your goal, then you would at least have the 
option of paying a higher premium so that it would.   Granted the 
higher premium might have been so high as to make the transaction 
marginal for you.   Nevertheless I was under the impression you had 
that choice, yet it seems very clear from what you are saying 'trader 
100' that as a exporter/importer, you don't.

SNOOPY



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