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Concept of Over/Under-Hedge

Forums › Ask ACCA Tutor Forums › Ask the Tutor ACCA AFM Exams › Concept of Over/Under-Hedge

  • This topic has 1 reply, 2 voices, and was last updated 1 year ago by John Moffat.
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  • August 11, 2021 at 5:24 am #631110
    siwela1
    Member
    • Topics: 24
    • Replies: 17
    • ☆

    Using this simplified example, can you explain the currency movement involved in a over/under hedge please.

    A UK company needs to make a US payment of $4.3 million.
    Future’s contract sizes = £31,250
    Lock-in rate on the future = US 1.4670 per £1

    Hence, # of contracts = (4,300,000/1.4670) / £31,250 = 93.80
    If I sell 94 contracts this is an over-hedge of US$9,312.50.

    Assuming the over-hedge will be settled on the forward market, I know the rate used will be the one least favourable to the UK company, but what is the flow of currency of the over-hedge,that is who holds the over hedge amount, currency exchanges made.

    August 11, 2021 at 8:19 am #631144
    John Moffat
    Keymaster
    • Topics: 56
    • Replies: 51585
    • ☆☆☆☆☆

    By having 94 contracts they will end up with $9,312.50 more than they actually need for the payment. Therefore they will sell the extra $’s so as to convert back to Pounds. Assuming that forward rates are available they will use the forward rate to convert the $’s back into Pounds.

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