The Handbook of Corporate Financial Risk Management (2nd Edition)
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How to Hedge High Carry Currencies
Foreword
Introduction
Theory and Practice of Corporate Risk Management
Theory and Practice of Optimal Capital Structure
Introduction to Funding and Capital Structure
How to Obtain a Credit Rating
Refinancing Risk and Optimal Debt Maturity
Optimal Cash Position
Optimal Leverage
Introduction to Interest Rate and Inflation Risks
How to Develop an Interest Rate Risk Management Policy
How to Improve Your Fixed-Floating Mix and Duration
Interest Rates: The Most Efficient Hedging Product
Do You Need Inflation-linked Debt?
Prehedging Interest Rate Risk
Pension Fund Asset and Liability Management
Introduction to Currency Risk
How to Develop Currency Risk Management Policy
Translation or Transaction: Netting Currency Risks
Early Warning Signals
How to Hedge High Carry Currencies
Currency Risk on Covenants
Optimal Currency Composition of Debt 1: Protect Book Value
Optimal Currency Composition of Debt 2: Protect Leverage
Cyclicality of Currencies and Use of Options to Manage Credit Utilisation
Managing the Depegging Risk
Currency Risk in Luxury Goods
Introduction to Credit Risk
Counterparty Risk Methodology
Counterparty Risk Protection
Optimal Deposit Composition
Prehedging Credit Risk
xVA Optimisation
Introduction to M&A-related Risks
Risk Management for M&A
Deal-contingent Hedging
Introduction to Commodity Risk
Managing Commodity-linked Revenues and Currency Risk
Managing Commodity-linked Costs and Currency Risk
Commodity Input and Resulting Currency Risk
Offsetting Carbon Emissions
Introduction to Equity Risk
Hedging Dilution Risk
Hedging Deferred Compensation
Stake-building
In this chapter, we continue the discussion of currency risk from EM currencies, while focusing on the high carry currencies – ie, those currencies with a high interest rate differential to G10 currencies. The topic of high carry has already been touched upon in Chapters 16 and 18, and it is important for many companies. Before we get into possible solutions, we should explain why this is the case.
We can broadly classify hedging costs in three categories: transaction cost; direct cost of administering the hedging program, and potential loss due to derivatives (counterparty loss, financial loss from the misuse of derivatives, reputational loss, etc.). However, cost of carry is nowhere in this list. So why do we call it a “cost” and why is it particularly important for high carry currencies? Let us take an example of the USDBRL exchange rate and how it impacts an exporter from USD to BRL. As of the time of writing, the spot exchange rate is 3.51 and one-year forward is 3.61.11 Source: BNP Paribas, May 1, 2018. Therefore, the level for forward exchange is 2.8% higher than the spot. However, 2.8% is just the relative difference in market levels at which the BRL proceeds can be
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