F.

MAYER IMPORTS :
HEDGING FOREIGN
CURRENCY RISK

Pearson Deaton
Kevin Grant
Rafi Goldman
Paulina Nowak
 Agenda

1.Introduction
2.Company overview
3. EX Risk Hedging Possibilities
4.Conclusion
F. Mayer Imports
Private company created in 1957 by Fredrick
Mayer

Headquarter in Banksmeadow, Australia

Import and distribution of high end European

food products in Australia
Business Overview
Import over 1,000 top quality products

Euro 70 Millions of product procurement

annually

Assets of the company are in AUD and liabilities

in EUR

Strong AUD/EUR exchange rate between 0.70-

0.80
 EX Risk Hedging Practice
Vanilla forward contracts – agreement for the future delivery of specific EX
at
specific date

Contract created at the time of the top EX AUD/EUR

Duration: 1-3 months; 30-40% of exposure has been hedged

Often after the hedge EX rose – company losing margins

However, at the end of 2013 EX started to be unfavorable:

• October 2013 EX AUD/EUR 0.7027

• January 2014 EX AUD/EUR 0.6369

Options to Hedge Risk
1. Not to hedge

2. Forward Contract

3. Put and Call Options

4. Collar Options

5. Knock in Forward Options

 Hedging EX Risk
Budget rate for 2014 - AUD/EUR 0.6900

Current trade AUD/EUR 0.6930

Liability: 70,000,000 EUR = $101,010,101 AUD

1.Not to hedge - If spot rate in 4 months will be higher than the FEC rate

2. Hedge with the 4 months Forward Exchange Contract at rate

AUD/EUR 0.6910

Liability: 70,000,000 EUR = $101,302,460 AUD

 OPTIONS
Contract that offers the buyer the right, but not the obligation, to buy (call
option) or sell (put option) the underlying asset at an agreed-upon price during
a certain period of time

Options are between two parties:

1. Holder – Buyer of the contract
2. Writer – Seller of the contract

The agreed upon price is called the strike price

Premium is the price paid for the option

 Put and Call Options
Call Option gives the holder the right but not the obligation
to buy an underling asset at specific price at a pre-
determined date

Mayer case: Call option is to buy Euro

Put Option gives the holder the right to sell an underling

asset at a specific price and a pre-determined date

Mayer case: Put Option is to sell AUD

 Put and Call Options F. Mayer Imports

Option 1 Option 2

Liability 70,000,000EUR Liability 70,000,000EUR

Strike 1 0.6910 Strike 1 0.6860
Converted to AUD $101,302,460 AUD Converted to AUD $102,040,816 AUD
Premium of 2.13% $2,157,742 AUD
Premium of 1.81% $1,846,939 AUD
Total AUD $103,460,203 AUD Total AUD $103,887,755 AUD

The first option gives a better rate that is 50 PIPS higher but the
premium is .32% higher
 Collar Option
• Simultaneously writing out-of-money call option and purchasing out-
of-money put option
• Both have same expiration date
• Maximum return (Best Case) = strike price of call
• Minimum return (Worst Case) = strike price of put
• If exchange rate remains between strike price of the call and put,
both options expire
• Why?
• Insurance if exchange rate becomes unfavorable

https://www.investopedia.com/terms/c/collar.asp
 Collar Option F. Mayer Imports
Expiration Date January 14, 2015
Value Date January 16, 2015
B Put Strike 0.6860 $102,040,816 AUD
S Call Strike 0.6942 $100,835,494 AUD
Range 0.0082

Expiration Date January 14, 2015

Value Date January 16, 2015
B Put Strike 0.6810 $102,790,015 AUD
S Call Strike 0.6983 $100,243,448 AUD
Range 0.0173
 Knock in Forward Option
• A knock-in option is a latent option contract that begins to
function as a normal option ("knocks in") only once a certain
price level is reached before expiration
• Knock-ins are a type of barrier option that are classified as
either down-and-in or an up-and-in
• A barrier option is a type of contract in which the payoff
depends on the underlying security's price and whether it hits a
certain price within a specified period

https://www.investopedia.com/terms/k/knock-inoption.asp#ixzz5XvOaqM4c
Knock in Forward Option F. Mayer Imports

Liability 70,000,000EUR

Spot Rate 0.6980 $100,286,533 AUD

Four Month FEC 0.6910 $101,302,460 AUD

Buy Put Strike 0.6890 $101,596,517 $294,056

Sell Call Strike 0.6890 $101,596,517
Knock in Forward Option F. Mayer Imports
With the first part of this solution you have the Buy option to Call(buy) Euro
and PUT (sell) AUD at .6890 which is 20 pips below the four month FEC
contract

This will cost you an additional $284,056 AUD but you also have the choice
to not exercise the option if the spot rate at the time is better then the
option rate

The second part of this option is the knock-in forward piece

If during the start time and Expiration time that rate increases to .7140 you
are knocked into a sell option to Call (Buy) AUD and PUT (Buy) Euro at the
same rate of .6890
Recommendation: Knock-In Option
• For the previous 12 months, the AUD/EUR had been trading well below the 0.6900
budget range
• Collar option locks in to a rate too low if it continues to fall (30-80 pips below the
knock-in rate of 0.6890)
• Not hedging too risky given weak consumer sentiment, falling iron ore price, and sub-
par economic growth
• Want to hedge against depreciating AUD while still leaving some wiggle room for profits if
it does appreciate
• Still don’t think it will reach the knock-in rate of 0.7140
• The 20 pips lost relative to the FEC of 0.6910 (given the liability of $70M EUR) is far
below the premium cost of the put/call options
• Willing to take on some risk and forgo the 20 pips (AU$294,056) relative to the 4-month
FEC in order to capitalize on the potential profits gained if the rate ends up being greater
than 0.6910 and less than 0.7140