Importer's USD Payable: Forward Versus Option Cover
A Johannesburg-based importer has a firm USD 1,200,000 payable in 90 days to a US supplier. The treasury desk observes spot USD/ZAR 18.4000/18.4500 and 90-day forward 18.5500/18.6000. ZAR 3-month money-market yield is 8.25% p.a. and USD 3-month yield is 5.25% p.a., both money-market conventions. The board has approved hedging at least 70% of the exposure and permits up to 100%. The treasurer expects the rand to strengthen to 18.10/18.15 over the period, but calls the view low-conviction. A dealer offers a 90-day USD call/ZAR put option at a strike of 18.60 for a premium of ZAR 0.42 per USD. The company is a ZAR functional-currency entity and can borrow USD only at USD yield plus 150 bp. It wants to compare full forward cover, 70% forward cover with the balance unhedged, and the option.
1. Calculate the all-in ZAR cost of full forward cover and the fair forward rate implied by covered interest parity. Is the quoted forward rich or cheap for a buyer of USD?
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The importer buys USD, so it pays the forward ask of 18.6000.
- Full forward cost = 1,200,000 × 18.6000 = ZAR 22,320,000.
- Fair forward ask using covered interest parity: (F = S_{ask} \times \frac{1 + r_{ZAR}t}{1 + r_{USD}t}) (= 18.4500 \times \frac{1 + 0.0825 \times 90/360}{1 + 0.0525 \times 90/360}) (= 18.4500 \times \frac{1.020625}{1.013125} = 18.5866).
The quoted ask of 18.6000 is about 1.34 cents above the parity fair value, or roughly 0.07%. It is therefore marginally rich for a buyer of USD, though the difference is small relative to the bid-offer spread and any bank credit charge. The quoted forward is not materially dislocated.
2. Compute the ZAR cost at the treasurer's expected spot of 18.15 under (a) full forward cover and (b) 70% forward cover with 30% unhedged. What does the comparison show about the treasurer's view?
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(a) Full forward cost = USD 1,200,000 × 18.6000 = ZAR 22,320,000.
(b) 70% forward:
- Hedged USD = 840,000; hedged cost = 840,000 × 18.6000 = ZAR 15,624,000.
- Unhedged USD = 360,000; at 18.15 cost = 360,000 × 18.15 = ZAR 6,534,000.
- Total = ZAR 22,158,000.
The 70% structure saves ZAR 162,000 versus full cover if the treasurer is right. At 18.10 the saving is about ZAR 180,000. That is only about 0.7%–0.8% of the payable, so the view is not worth taking as an all-or-nothing bet. The board's 70% minimum hedge is the dominant constraint; the remaining 30% is a modest tactical position. If the rand weakens instead, the unhedged 30% loses much more than the expected saving, so the treasurer should size the open position to governance tolerance, not conviction alone.
3. Calculate the break-even spot for the option versus the forward, ignoring the time value of money, and advise which hedge structure fits the stated view and governance constraints.
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Option premium = 1,200,000 × 0.42 = ZAR 504,000.
If spot at expiry is below the 18.60 strike, the option is not exercised and cost = 1,200,000 × S + 504,000. Set this equal to the forward cost of 22,320,000:
(1,200,000S + 504,000 = 22,320,000) (S = \frac{21,816,000}{1,200,000} = 18.18).
So the option beats the forward only if spot ends below about 18.18. At the treasurer's 18.10–18.15 view, the option saves roughly ZAR 36,000–96,000, but the premium is ZAR 504,000 and the maximum cost if the rand weakens is 22,824,000. Given low conviction and a 70% minimum hedge, a sensible structure is 70% forward cover plus an option or partial option on part of the remaining 30%, rather than paying for full option cover. The forward protects the budget; the option retains limited upside if the rand strengthens.