CitiFX | Client Solutions
May 2014
Hedging Forecasted Cash Flows A rules based approach to G10 and EM Hedging
Matthieu Brunet CitiFX Client Solutions
[email protected] +44 20 7986 9174
Sources of Currency Risk
Transaction
Translation
Forecasted Transactions
Yield
Foreign Liabilities
Currency Clauses
Cash
Divestments Net Investments
Tax
Bid-to-award
M&A Payables Receivables
Dividends Pensions
Capex
1
Earnings
Inter-Co Loans
Forecasted Cash Flow Hedging
2
In G10, focus on carry and valuation The dynamic layered hedging program is a two-step process
Hedging strategy – Select hedging weights looking at valuation – Select the hedging instruments looking at valuation and carry Valuation
3
Instrument Matrix
In EM, focus on levels of risk (EWS Heat Map)
Below average risk
Above average risk
Hedge signal** Money supply
Industrial prod.
Exports
CDS spread
Equities
Eco surprises
Global risk
REER
99%
92%
58%
88%
81%
37%
98%
81%
40%
39%
80%
96%
100%
98%
61%
88%
44%
69%
61%
76%
94%
8%
34%
25D
74%
68%
46%
74%
48%
81%
2%
68%
66%
86%
52%
34%
11%
-
Fwd
25%
99%
65%
78%
4%
16%
-
Fwd
65%
96%
89%
90%
4%
40%
90%
97%
54%
26%
100%
99%
72%
29%
29%
2.1% ▲
ATMF
25D
93%
69%
62%
84%
70%
40%
0%
72%
71%
51%
48%
34%
57.9%
3.7% ▲
ATMF
25D
57%
65%
79%
74%
24%
5%
72%
64%
85%
57%
78%
26%
13%
Brazil
55.5%
-0.2% ▼
-
Fwd
63%
73%
61%
84%
Chile
55.1%
-3.3% ▼
-
Fwd
53%
67%
66%
31%
79%
42%
70%
56%
83%
12%
32%
11%
93%
90%
54%
8%
91%
62%
44%
Colombia
54.2%
-0.6% ▼
-
Fwd
89%
57%
48%
3%
84%
95%
41%
33%
21%
71%
78%
25%
10%
Croatia
53.9%
-5.7% ▼
-
Fwd
36%
39%
Russia
53.8%
1.2% ▲
25D
ATMF
51%
68%
77%
30%
44%
98%
14%
90%
84%
34%
49%
62%
52%
74%
19%
66%
86%
84%
26%
Serbia
53.5%
-1.5% ▼
-
Fwd
86%
4%
64%
88%
25%
56%
56%
8%
89%
54%
27%
Romania
51.4%
3.5% ▲
25D
ATMF
52%
46%
23%
40%
78%
77%
19%
66%
33%
29%
54%
Mexico
49.1%
-2.2% ▼
-
Kazakhstan
49.1%
2.6% ▲
-
Fwd
70%
48%
67%
55%
26%
39%
45%
14%
76%
45%
30%
Fwd
37%
46%
74%
29%
80%
17%
29%
72%
72%
32%
Uganda
47.3%
-4.8% ▼
-
Fwd
96%
66%
43%
29%
15%
13%
38%
30%
99%
Egypt
47.2%
2.3% ▲
-
Fwd
64%
41%
63%
87%
0%
61%
0%
92%
6%
37%
73%
Thailand Bulgaria
46.8%
2.0% ▲
-
Fwd
17%
59%
95%
73%
51%
14%
18%
39%
87%
25%
16%
46.8%
1.3% ▲
-
Fwd
99%
54%
32%
84%
47%
61%
39%
0%
33%
50%
Risk index
Poland
45.6%
0.3% ▲
-
Fwd
84%
55%
36%
54%
59%
52%
15%
6%
31%
69%
28%
60%
btw. 50-55%
Peru
43.9%
-9.2% ▼
-
Fwd
71%
45%
80%
43%
47%
7%
24%
77%
44%
32%
23%
Israel
43.3%
6.0% ▲
-
Fwd
30%
38%
47%
85%
49%
8%
12%
16%
34%
27%
76%
South Korea
43.0%
-1.7% ▼
-
Fwd
19%
27%
54%
44%
62%
61%
30%
2%
49%
69%
28%
71%
Risk index
Hungary
42.9%
-3.0% ▼
-
Fwd
10%
25%
25%
59%
63%
76%
35%
80%
61%
12%
25%
43%
below 50%
Pakistan
42.6%
0.2% ▲
-
Fwd
70%
84%
42%
30%
0%
31%
34%
96%
7%
29%
45%
Nigeria
42.1%
-3.4% ▼
-
Fwd
28%
51%
46%
75%
4%
21%
6%
60%
27%
93%
Singapore
41.3%
2.6% ▲
-
Fwd
2%
33%
13%
50%
53%
93%
6%
71%
68%
30%
37%
China
41.0%
-2.3% ▼
-
Fwd
30%
48%
23%
82%
6%
20%
3%
15%
75%
98%
27%
65%
Philippines
40.2%
1.2% ▲
-
Fwd
23%
92%
63%
20%
57%
22%
12%
23%
80%
45%
27%
20%
Kenya
36.9%
-1.7% ▼
-
Fwd
100%
46%
43%
83%
34%
45%
2%
Malaysia
36.7%
-1.9% ▼
-
Fwd
13%
60%
30%
53%
45%
48%
23%
Saudi Arabia
33.7%
-3.3% ▼
-
Fwd
5%
55%
41%
53%
45%
0%
Taiwan
33.1%
5.2% ▲
-
Fwd
7%
43%
51%
62%
20%
29%
5%
Czech Republic
31.3%
0.7% ▲
-
Fwd
70%
15%
31%
47%
33%
41%
5%
MoM
External Long EM Short EM financing
April 2014
Index*
Ukraine
76.2%
2.1% ▲
-
Fwd
Turkey
59.0%
-2.9% ▼
-
Fwd
Indonesia
59.0%
1.2% ▲
ATMF
Venezuela
58.6%
-0.6% ▼
Argentina
58.5%
4.0% ▲
South Africa
58.2%
India
Loan-toShortImplied deposit term debt FX vol
* - The EWS risk indices are calculated as average rolling percent ranks of 12 indicators of economic and financial stress. The indices vary between 0% (low risk) and 100% (high risk).
4
53%
74%
68%
17% 22%
61%
0%
54%
1%
above 65%
Risk index
28% 23%
Risk index
30%
34%
28%
56%
50%
30%
30%
40%
58%
20%
32%
23%
Source: Citi; Sample: 30 April 2014
btw. 55-65%
What about portfolio risk? The portfolio VaR is EUR 384k whereas the sum of the individual VaR’s is EUR 641k. Concentration Risk: Although 50% of the notional exposures are G10 based, 60% of the portfolio risk is in the EM currencies. The currencies with best hedging cost to risk ratios are USD and JPY (earning carry) and GBP and SEK (paying carry).
Underlying Exposure plus Forwards Portfolio
Currency JPY CHF USD GBP SEK HUF PLN TWD RUB TRY TOTAL
Exposures EUR Equiv. 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 10,000,000
Sum of Individual VaRs Total Portfolio VaR Diversification Benefit Diversification Benefit (%) Portfolio Volatilty
5
Individual 3M VaR - EUR @ 95% C.L. 91,182 31,069 63,007 56,379 62,646 62,173 46,967 56,274 63,490 107,598 640,783
EUR Equivalent 640,783 383,605 -257,178 -40% 4.7%
Component 3M VaR - EUR @ 95% C.L. 54,747 3,025 34,243 29,791 33,414 28,912 23,341 35,089 49,423 91,620 383,605
Contribution to Risk 14.3% 0.8% 8.9% 7.8% 8.7% 7.5% 6.1% 9.1% 12.9% 23.9% 100%
Marginal 3M VaR - EUR @ 95% C.L. -46,760 -1,771 -30,262 -26,567 -29,427 -24,666 -21,043 -32,323 -47,055 -86,220
Hedging (Costs) / Benefits Using Forwards EUR Equiv 467 768 12 -637 -1,534 -4,344 -5,543 4,164 -15,585 -19,013 -41,244
Earning Carry
Paying Carry
Marginal VaR Impact per EUR1 earned -100 -2 -2,525
Marginal VaR Impact per EUR1 spent
-42 -19 -6 -4 -8 -3 -5
Individual Volatilities 11.1% 3.8% 7.7% 6.9% 7.6% 7.6% 5.7% 6.8% 7.7% 13.1%
Portfolio Risk – Efficient Frontier The following chart compares a 50% hedged portfolio with the portfolios on the efficient frontier
VaR vs. Hedging (Costs)/Benefits
Fully Hedged 0 P1
P2
(50,000)
P3
P4 (100,000)
P5 P6
(150,000)
P7
VaR
P8
50% Hedged Portfolio
(200,000)
P9 (250,000) P10 (300,000)
P11
(350,000) Unhedged
(400,000)
(450,000) (50,000)
(40,000)
(30,000)
(20,000)
Hedging (Costs)/Benefits
6
(10,000)
0
10,000
Back Testing Results Cash flow hedging in G10 and EM
G10 cash flow hedging: short EUR/USD case study The table presents summary statistics from the hedges examined including the dynamic program 18-month hedging tenor, Q-on-Q changes – WERM +/- 10% – Carry +/- 1% – Historical data set: Q2 1993 - Q1 2013 The average achieved rate of 1.2080 is significantly better than all of the other programs evaluated. The standard deviation is on par with the other layered programs.
Average Best-case Worst-case VaR (95%) Standard deviation
7
Back Testing Results
Unhedged
Rolling Forward
Layered Forward
Rolling Option
Layered Option
Rolling Collar
Layered Collar
1.2220
1.2232
1.2243
1.2183
1.2212
1.2185
1.2224
Rolling Particip. Forward 1.2216
9.7%
9.3%
3.5%
9.0%
8.6%
9.4%
4.1%
9.0%
6.0%
6.1%
(-4%)
(-64%)
(-7%)
(-12%)
(-3%)
(-57%)
(-7%)
(-38%)
(-37%)
-12.6%
-4.6%
-13.9%
-7.4%
-12.6%
-4.7%
-12.6%
-4.7%
-10.1%
(-6%)
(-65%)
(4%)
(-45%)
(-6%)
(-65%)
(-6%)
(-65%)
(-25%)
-8.3%
-3.8%
-7.3%
-4.7%
-8.0%
-3.4%
-7.6%
-3.3%
-4.0%
(-3%)
(-55%)
(-14%)
(-45%)
(-6%)
(-60%)
(-11%)
(-61%)
(-53%)
5.0%
2.2%
4.8%
3.3%
4.7%
2.3%
4.4%
2.5%
2.7%
(-2%)
(-58%)
(-7%)
(-36%)
(-8%)
(-56%)
(-15%)
(-52%)
(-48%)
-13.4% -8.5% 5.1%
Layered Particip. Forward 1.2235
Dynamic 1.2080
EM cash flow hedging: short EUR/BRL case study This study looks at layered hedging and the effect of using EWS as a decision tool for EUR/BRL. – The underlying exposure is short EUR / long BRL – The analysis is from December 2005 until January 2014. – The analysis assumes a 100% hedge ratio is achieved for the rolling & layered hedging strategies – The hedging program is based on monthly implementation points with equal weights per month The Early Warning Signal layered hedging program works as a standard layered program, but with hedges only placed if a hedge signal is produced. The average rate achieved for the 6m EWS Layered compared to 6m rolling forwards and Layered Forwards has been improved by 6 big figures and 3 big figures on average per month since 2005. Using EWS layered hedging produces a lower volatility compared to both the unhedged case and the rolling program.
12/2005 to 12/2013
Unhedged
6m Rolling
6m Layered
6m EWS Layered
Avg. Effective Rate
2.6229
2.6821
2.6525
2.6201
Best Case
8.8%
8.8%
3.0%
6.5%
Worst Case
8
(16.8%)
(16.9%)
(4.8%)
(12.1%)
VaR (95%)
(8.5%)
(7.7%)
(3.0%)
(5.2%)
St. dev. (1m)
4.4%
4.4%
1.5%
3.3%
Back Testing Results
EWS
Hedge
< 50%
Unhedged
50% - 55%
25D
55% - 65%
ATMF
above 65%
Forward
Signal Sum m ary 25D
17.5%
ATMF
21.6%
Forw ard
3.1%
Total Hedge
42.3%
Unhedged
57.7%
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