Hedging a Receivable in a Currency With No Forward Market
A Vancouver equipment exporter has won a contract worth KES 90 million, payable in Kenyan shillings in 180 days. The company's bank can quote a forward for major currencies but not for KES against CAD. The treasurer obtains a USD/KES forward quote and a CAD/USD forward quote, both available for the same 180-day tenor. Spot rates are CAD/USD 1.3650 and USD/KES 129.40. The 180-day forwards are CAD/USD 1.3720 and USD/KES 133.10. The treasurer proposes a synthetic forward by selling KES forward against USD and selling USD forward against CAD. The CFO is concerned that the synthetic rate will differ from what a direct quote would have been, and asks whether the company is taking on basis or credit risk it has not priced.
1. Calculate the synthetic CAD/KES 180-day rate implied by the two forwards and explain the economics of the construction.
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The synthetic rate is built by chaining the two legs so the USD cancels.
Leg one: sell KES forward against USD at 133.10, so KES 90,000,000 / 133.10 = USD 676,183.32 receivable in 180 days.
Leg two: sell that USD forward against CAD at 1.3720, giving USD 676,183.32 x 1.3720 = CAD 927,723.52.
Implied synthetic rate: 927,723.52 / 90,000,000 = CAD 0.010308 per KES, or roughly CAD/KES 97.01.
The construction works because the USD leg is matched in amount and value date, so the company has no residual USD exposure. Economically it is equivalent to a direct forward if markets are arbitrage-free, because covered interest parity links the three currency pairs. Any difference from a direct quote would reflect the dealer's spread on two transactions rather than one, plus any liquidity premium in the less-traded KES leg.
The company should compare the synthetic all-in rate against the unhedged spot expectation and against the cost of simply invoicing in USD, which may be negotiable with the buyer.
2. Identify the risks the synthetic structure introduces that a direct forward would not, and recommend how to manage them.
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The main incremental risks are execution and settlement, not market risk.
Settlement risk arises because the two legs may settle with different counterparties or at slightly different times. If the KES leg settles and the USD leg fails, the company holds unhedged USD. Mitigation is to use the same bank for both legs where possible, or to require simultaneous settlement and confirm value dates in writing.
Credit risk is doubled: two counterparties must perform instead of one. The company should set counterparty limits and confirm the bank's credit standing for both legs.
Basis and rollover risk matter if the receivable date slips. A 180-day forward that must be extended or closed early incurs a new spread, and the KES leg is the expensive one to unwind because of limited liquidity. The company should build a buffer into the hedge ratio, hedging perhaps 80 to 90 percent of the exposure and leaving the remainder to absorb timing slippage.
Operationally, the synthetic requires the treasury system to track two linked deals as one exposure. Without that linkage, the position report will show an open USD position that does not exist economically. Documentation should record the hedge relationship for accounting purposes so the two legs are not assessed separately.