RM119 Treasury Risk Management For The Corporation

RM119 Treasury Risk Management For The Corporation

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RM119 Treasury Risk Management For The Corporation

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RM119 Treasury Risk Management For The Corporation

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Course Code: RM119
University: Institute Of Singapore Chartered Accountant

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Country: Singapore

Identify the risks of each strategy and estimate the dollar cash flows it will receive as a result of using each strategy. To do so you must consider a number of different exchange rate outcomes at the end of one year ranging from the dollar depreciating to the dollar appreciating against the euro.
Explain which hedge you think is optimal for ABC. 

There are a number of risks that un-hedged strategy is exposed to. In fact, the un-hedged strategy is exposed to all four significant risks in the foreign exchange market. These include leverage risk, Interest rate risks, Transaction risks, counterparty risks, and country risks (Calverton Finance, 2015). For example, transaction risk can affect the amount ABC receives if the exchange rate between Euro and dollar will occur before one year elapses (Bollen, 2013).
Consequently, the expected amount from the receivables with un-hedged strategy will be given by:

Forward hedge Strategy

The main risk facing Forward Hedge Strategy is counterparty risk, default risk (Walmsley, 2011). In case counter-party is needed, it may be difficult to find a suitable counter-party to buy the contract. Additionally, financially, there is always the likelihood of default. Therefore, in case the issuer of the contract is unable to meet the obligations of the contract, then ABC might suffer a loss due to default risk (Riehl, 2015).
Forward hedge strategy us the same as the market hedge if the Interest Rate Parity exists, and ABC bank does not incur commission costs. This is a result of interest rate differential between the Euro and Dollar being reflected by the forward premium on the forward rate of Euros.  However, assuming that ABC does not satisfy Interest Rate Parity,

Money Market Hedge

Money market hedge faces similar risks to forward hedge strategy. However, the main risks facing money market hedge are default risk, transactional risk, and counter-party risk (Lakshman, 2009). The bank accepting deposits may go under hence exposing the deposit to default risks. Besides, it may not be easy to get counter-party, if needed (Kaplan Financial Knowledge Bank, 2012).
Money market hedge is the hedge against exposure resulting from foreign currency risks. The risk is created by borrowing or fixing payments and receipts in domestic currency by depositing an acceptable sum of money today.  Since ABC Company is expected to receive a 50 million Euro Payment, foreign currency receipt strategy of money market hedging is used. According to the money Market strategy,
Therefore, for ABC to apply money market Strategy, it will borrow Euro, convert the amount to dollars, invest the dollars, and then repay Euro loan in one year.
For one year period, the interest rate in the United States is 5.5%. Investing the dollars in the U.S, the accumulated amount at the end of one year is calculated as:
Thus using the money market hedging strategy, ABC will be worth $56,887,254.90 at the end of the one year.

Option Hedge

The main risk of option hedge strategy is the existence of probability of losing 100% premium paid (Riehl, 2015). That is the uncertainty in option hedging potentially unlimited. Besides, currency options can be illiquid hence making it difficult to convert to cash. Consequently, there is a probability that this strategy may render ABC’s investment worthless (Walmsley, 2011).
ABC should purchase a one-year put option to hedge receivables. The given exercise is $1.11/$, with one-year expiry. The following is the probability distribution of the United States Dollars to be received in a one-year period:

Possible Spot Rate in one year (Forecasted spot rate):

Premium per dollar paid for the option

Exercise Option Alternative?

The amount Received per unit after accounting for the premium.

The total amount of dollars acquired from the conversion of 5000000 Euros.






Hence using put option hedging strategy gives an expected cash receipt of $53,500,000.

Optimal Hedge

Money market strategy is the optimal hedging strategy from the above four strategies. Comparing the above four approaches, money market strategy provides the highest amount of cash in one year.


Value of the Cash Flow

Un-hedged Strategy


Forward Hedge Strategy


Money Market Hedge


Option Hedge


Bollen, B., 2013. To hedge or not to hedge. [Online] Available at: https://www.ft.com/content/5f33f404-953c-11e2-a151-00144feabdc0 [Accessed 18 September 2018].
Calverton Finance, 2015. Foreign Exchange Risks – The very basics. [Online] Available at: https://www.calvertonfinance.co.uk/blog/foreign-exchange-risks—the-basics.html [Accessed 18 September 2018].
Kaplan Financial Knowledge Bank, 2012. Money Market Hedges. [Online] Available at: https://kfknowledgebank.kaplan.co.uk/KFKB/Wiki%20Pages/Money%20Market%20Hedges.aspx [Accessed 18 September 2018].
Lakshman, R., 2009. An Introduction to Foreign Exchange & Financial Risk Management. 1st ed. Mumbai: Shroff Publishers and Distributors Pvt. Ltd.
Riehl, H., 2015. Managing Risk in the Foreign Exchange, Money and Derivative Markets. 3rd ed. New York: McGraw-Hill Education.
Walmsley, J., 2011. International Money and Foreign Exchange Markets: An Introduction. New York: Wiley.

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