Hedging a USD Receivable with Forwards or a Zero-Cost Collar
Daehan Precision, a Korean auto-parts exporter, expects to receive USD 25 million in six months. The current spot rate is KRW 1,340 per USD; the six-month forward is KRW 1,318. Six-month USD/KRW implied volatility is 9%. A bank offers two hedges: (i) a forward contract at 1,318, or (ii) a zero-cost collar that buys a USD put at 1,300 and sells a USD call at 1,390. Daehan's treasury policy requires hedging at least 70% of any single currency exposure, prohibits paying a net option premium, and caps notional with any one bank at KRW 15 billion. The CFO wants to keep some upside if the won weakens past 1,390 but is worried about a sharp won appreciation. The company's EBIT margin is 7%, and a move from 1,340 to 1,250 would cut operating profit on this receivable by roughly KRW 2.25 billion.
1. Calculate the hedged KRW proceeds at maturity under the forward and the collar for spot rates of 1,250, 1,318, and 1,420. Which hedge meets the treasury policy?
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Forward proceeds: USD 25m x 1,318 = KRW 32.95bn at every spot. Collar: buy put 1,300, sell call 1,390. At 1,250, the put pays; proceeds = 25m x 1,300 = KRW 32.50bn. At 1,318, neither option is exercised; proceeds = 25m x 1,318 = KRW 32.95bn. At 1,420, the call is exercised; proceeds = 25m x 1,390 = KRW 34.75bn. Policy: hedge at least 70% = USD 17.5m; both structures can cover the full USD 25m. No net premium: both satisfy. Bank cap: full notional at 1,340 is KRW 33.5bn, above the KRW 15bn single-bank cap, so Daehan cannot execute the full hedge with one bank. It must split across at least three banks or hedge only KRW 15bn per bank; a single-bank full hedge would breach policy. If split, the forward locks 32.95bn; the collar floor is 32.5bn and cap 34.75bn.
2. Evaluate the CFO's statement that the collar 'keeps upside' while protecting against won appreciation. Quantify the trade-off and discuss whether the 1,390 call strike is consistent with the 7% EBIT margin and the KRW 2.25 billion sensitivity.
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The collar does preserve upside, but only between 1,300 and 1,390, and the upside is capped at 34.75bn versus 35.5bn unhedged at 1,420. Relative to the forward, the collar gives up KRW 0.45bn at 1,250 but gains KRW 1.8bn at 1,420. The 1,390 call is about 5.3% above the forward and 3.7% above spot, so the retained upside is modest. The EBIT margin is 7% of revenue, about KRW 2.35bn on KRW 33.5bn; a move to 1,250 cuts profit by KRW 2.25bn, nearly all of it. A floor at 1,300 still leaves KRW 1.0bn below budget (40 KRW x 25m), so the CFO should compare the floor to the budget rate, not just spot. If the budget rate is near 1,340, a 1,300 floor is insufficient protection; a higher floor would require a lower call strike or a premium, conflicting with the zero-premium policy. The collar is policy-compliant but not necessarily risk-adequate.
3. Identify the main residual risks of the recommended hedge structure and how Daehan should monitor them.
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Residual risks include counterparty credit risk on the forward or option, because a bank default before settlement would leave the receivable unhedged; split the notional and monitor bank ratings and collateral terms. There is basis risk from timing and amount: the receivable may arrive early or late, or the actual USD amount may differ, so the hedge ratio is not exact. There is also cross-basis risk if the exposure is not purely USD/KRW. Liquidity and margin risk arise on forwards if the won moves sharply. Operational and accounting risk include hedge documentation and effectiveness testing. Monitor mark-to-market, hedge ratio, bank credit limits, and the collar's mark; stress test at 1,250 and 1,420. If the bank cap forces partial hedging, the unhedged residual should be reported to the CFO and treasury committee.