Hedging strategies for exchange rate exposure with different scenarios

1. FINANCIAL RISK MANAGEMENT
PIXONIX INC CASE
prof. Barbara Alemanni
EMBAS14
ELABORATO A CURA DI ENRICO CESARI, SERGIO DELL’ETERE,
FERDINANDO FERRARI BRAVO
01 SETTEMBRE 2015

2. 2
SIMULAZIONE PORTAFOGLIO – OVERVIEWSUMMARY
1. BACKGROUND
2. RISK ASSESSMENT (NO HEDGE)
3. PUT OR CALL OPTION
4. FORWARD CONTRACT
5. CONCLUSIONS: CURRENCY EXPOSURE STRATEGY

3. 3
SIMULAZIONE PORTAFOGLIO – OVERVIEWPIXONIX INC
1. BACKGROUND
Friday November the 2nd, 2007
Mikayla CAIN, CFO @ Pixonix (Toronto – Canada)
Current CAD = USD 1,0717 => USD = 0,933 CAD
Spot RATE on November the 2nd => USD = 0,9351 CAD
Purchase of USD 7,5 million on January the 31st 2008
2. RISK ASSESSMENT (NO HEDGE)
SHORT POSITION against exchange rate
USD/CAD
Cain is concerned due to the business model
structure: revenues in CAD (and cash flows to
be converted in USD) and a “significant
portion” of costs in USD
↑ ⇒ (1.500.000)
(1.300.000)
(1.100.000)
(900.000)
(700.000)
(500.000)
(300.000)
(100.000)
100.000
300.000
500.000
0,9
0,91
0,92
0,93
0,94
0,95
0,96
0,97
0,98
0,99
1
1,01
1,02
1,03
1,04
1,05
1,06
1,07
1,08
1,09
1,1
↓ ⇒

4. 4
SIMULAZIONE PORTAFOGLIO – OVERVIEWPIXONIX INC
3. PUT OR CALL OPTION
a. Scenario USD = CAD
b. Scenario USD = 0,9 CAD
c. Scenario USD = 1,1 CAD
AMERICAN HOLD/LONG CALL OPTION
Underlying asset: USD/CAD exchange rate
Purchase: USD 7,5m
Expire date (3MM): end of January 2008
Strike price: 0,935 (the nearest to 0,9351)
Premium fee: 1,73% of Face Value
=> 129.750 USD
=> 121.329 CAD
SENSITIVITY ANALYSIS
Option is exercised at 0.9, it’s aborted at 1.0 and 1.1
(1.500.000)
(1.000.000)
(500.000)
0
500.000
1.000.000
1.500.000
0,9
0,91
0,92
0,93
0,94
0,95
0,96
0,97
0,98
0,99
1
1,01
1,02
1,03
1,04
1,05
1,06
1,07
1,08
1,09
1,1
CAD
USD
/CAD
NO HEDGING CALL OPTION NET POSITION
0,9 263.250 -121.329 141.921
1,0 -486.750 366.171 -120.579
1,1 -1.236.750 1.116.171 -120.579

5. 5
SIMULAZIONE PORTAFOGLIO – OVERVIEWPIXONIX INC
4. FORWARD CONTRACT
Underlying asset: USD/CAD exchange rate
Purchase: USD 7,5m
Expire date (3mm): end of January 2008
Spot rate: 0,9351
Forward rate: 0,93499 (ASK)
SENSITIVITY ANALYSIS
The 3 scenarios are indifferent.
If we would estimate the PRICE of the FORWARD CONTRACT we should consider the interest
rates in domestic and foreign currencies applying the following formula:
CAD
USD
/CAD
NO HEDGING FORWARD NET POSITION
0,9 263.250 -262.425 825
1,0 -486.750 487.575 825
1,1 -1.236.750 1.237.575 825
(1.500.000)
(1.000.000)
(500.000)
0
500.000
1.000.000
1.500.000
0,9 1,0 1,1
3 = ℎ ∗ ∗
(1 +
90
360
)
(1 +
90
360)

6. 6
SIMULAZIONE PORTAFOGLIO – OVERVIEWPIXONIX INC
5. CONCLUSIONS: CURRENCY EXPOSURE STRATEGY
Cain should cover the currency exposure with a FORWARD CONTRACT for the following reasons:
• The amount of costs occurred in USD is a very relevant part of the total costs => cover the exchange
rate is a critical topic
• Company’s strategy is risk adverse (ie only operational risks) therefore the policy is to hedge the risk
due to reduce cash-flows volatility (band buffer)
• Company doesn’t trust RBC’s short-term forecast (ie USD/CAD drops down to 0,926 until the first half
of the next year)
In fact, FORWARD CONTRACT has the lowest volatility:
If Cain has a speculative approach she could stipulate a CALL OPTION to enjoy benefits from the
decrease of the rate USD/CAD. A CALL OPTION allows to postpone the decision and is reversible.
In our opinion the NO HEDGING approach is to avoid in any case.
CAD
NO HEDGING
CALL NET
POSITION
FORWARD
NET POSITION
VOLATILITY 1.500.000 262.500 0