Hedging a USD Receivable under a Board Hedge Policy
A Hong Kong toy exporter expects to receive USD 20m in six months. Its board policy requires hedging at least 75% of foreign-currency receivables within five business days of invoicing. Spot USD/HKD is 7.8000; the six-month forward is 7.8300. The treasurer expects HKD to weaken to 7.8500 and wants to leave the exposure unhedged to capture the gain. A bank offers a six-month USD put/HKD call option with a strike of 7.8200 for a premium of 1.2% of notional, or a 'target redemption forward' with strike 7.8250, a knock-out at 7.7000, and 2x leverage if the knock-out is hit. The CFO asks whether the policy permits no hedge, how much to hedge, and whether either structured product is suitable. The accounting team wants to avoid cash-flow hedge accounting complexity and the company has no ISDA master agreement with the bank.
1. How much must the company hedge under its policy, and what does the forward lock in compared with the treasurer's view?
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The policy requires hedging at least 75% of USD 20m, so the minimum hedge is USD 15m. Leaving the full USD 20m unhedged would breach the board policy and would be a governance failure, even if the treasurer expects HKD to weaken to 7.8500. The forward at 7.8300 locks in HKD 117.45m for USD 15m. If the company hedged the full USD 20m, it would lock in HKD 156.60m.
If spot reaches 7.8500, the unhedged 5m would convert to HKD 39.25m, while the hedged 15m would produce HKD 117.45m, total HKD 156.70m. That is only HKD 0.10m better than hedging all at 7.8300. If HKD instead strengthens to 7.7500, the 5m unhedged would lose HKD 0.40m against the forward rate. The forward removes uncertainty but gives up upside. The treasurer's directional view is not a substitute for policy compliance.
2. Compare the option, the target redemption forward and a plain forward for this exporter, and identify the documentation issue.
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The exporter needs to sell USD. A plain forward locks in 7.8300 and is simple, but it gives up upside if HKD weakens. The USD put option with a 7.8200 strike protects against HKD strengthening while leaving upside, but it costs 1.2% of notional. On USD 15m, that is USD 180,000, a real cash cost. The target redemption forward has a knock-out at 7.7000 and 2x leverage. If the knock-out is hit, the hedge may disappear just when protection is needed, and the leverage can create a loss larger than the underlying exposure. That is unsuitable for a hedger whose objective is to reduce risk, not to take a directional view.
The company also has no ISDA master agreement, so it cannot execute OTC forwards or options with the bank until documentation, credit limits and collateral terms are agreed. Exchange-traded futures or a simpler bank forward may be more appropriate. The accounting team's wish to avoid hedge accounting does not justify leaving risk unhedged; the company should assess whether the chosen hedge qualifies for hedge accounting or accept earnings volatility.