FIN.14:4.3 - Choose quantity and dates from the residual exposure

Use gross exposure, reliable offsets and the intended protected portion to establish the proposed amount. The denominator of a hedge ratio must be clear: forecast sales, contracted invoices, expected collections and a price sensitivity are different quantities. A “100% hedge” of a forecast is not necessarily a full match to what will actually be delivered.

For a foreign receipt Q and a forward sale of h foreign units at home-per-foreign rate F, the combined terminal home cash, before charges and financing, is Q × S + h × (F − S), provided all stated transactions can actually settle. With fixed Q and h = Q, the expression becomes Q × F. With h different from actual Q, the remaining market sensitivity is Q − h. In a physical settlement, insufficient foreign receipts still have to be purchased; the algebraic net amount does not fund that purchase beforehand.

If the amount or date is uncertain, compare several protection quantities or a rule for changing them as the exposure becomes firmer. A firm delivery duty for the reasonably supported minimum and optional protection for additional volume can have different consequences from fixing the full forecast. These are alternatives to evaluate, not universal percentages. Test the lower-volume and delayed cases explicitly. Treat a rolling hedge as a sequence of future transactions with future prices, access and costs; successive short contracts do not establish today’s long-term fixed price.

Choose the reference and maturity from the actual exposure. For borrowing, match reset and accrual periods as well as nominal maturity. For a commodity, identify location, grade, delivery period and any difference between the purchased commodity and the traded reference. For an option, determine when the relevant uncertainty is resolved and whether exercise remains possible then. An offset that works at expiry may have large intervening value and cash changes.

Where an imperfect proxy is proposed, estimate how its payoff changes with the exposure on the relevant horizon and inspect unlike conditions. A regression or covariance estimate can support a quantity aimed at reducing historical variance under its assumptions. It does not establish the quantity that preserves a future cash floor, or that the relationship will persist during the material stress. Use the objective to choose the comparison and return the resulting residual exposure to FIN.13.