Atlantis Marine: Hedging a Conditional Euro Receivable
Atlantis Marine Ltd, a UK boatbuilder with EBITDA of £3.2m, has won a €24m contract to deliver 12 vessels to a Norwegian ferry operator, payable in euros in nine months. Treasury's base case uses EUR/GBP 0.8500. A 5% adverse move in the euro would erase about 40% of EBITDA. The bank quotes a nine-month forward at 0.8420, a EUR put option at a strike of 0.8450 with a premium of 1.8% of the euro notional, and money-market rates of 5.0% for euro borrowing and 3.0% for sterling deposits (annualised, actual/365). The CFO favours the forward because it is free; the sales director wants the option to keep upside; the chair asks whether a collar would be cheaper. Atlantis has a £1.5m overdraft and a covenant requiring EBITDA/interest cover above 3.0×. The contract is subject to the ferry operator confirming its financing within 60 days.
1. Compare the forward, option and money-market hedges for the €24m receivable. What are the locked-in sterling proceeds and the break-even rate for the option?
Read the worked answer
Forward: €24m × 0.8420 = £20.208m certain.
Option: gross at strike = 24 × 0.8450 = £20.280m. Premium = 1.8% × €24m = €0.432m; at 0.8500 that is £0.367m. Net floor = £19.913m. Break-even rate = 0.8450 + (0.367/24) = 0.8603. Above that the option beats the forward.
Money market: borrow euro present value = 24/(1 + 0.05 × 0.75) = €23.133m; convert at 0.8500 = £19.663m; deposit for nine months at 3.0% = £19.663m × 1.0225 = £20.105m. The small gap from the forward reflects spreads and the quoted rates.
On certain proceeds the forward is best (£20.208m), the money market is £0.103m lower, and the option floor is £0.295m lower but retains upside above 0.8603. Given EBITDA of £3.2m, a 1.8% premium is about 11% of EBITDA, which is material. A risk-averse board with a tight covenant should hedge most of the exposure with the forward and perhaps buy options on a small tranche for upside. Do not hedge the full amount until the contract is confirmed.
2. The chair asks about a collar. Explain how a collar would work, what it would cost, and the trade-offs.
Read the worked answer
A collar combines a bought EUR put (floor) with a sold EUR call (cap). Atlantis would buy the 0.8450 put and sell a call at, say, 0.8750. The call premium received offsets the put premium; if the strikes are chosen so premiums match, the collar is zero-cost. Proceeds would then be between 24 × 0.8450 = £20.28m and 24 × 0.8750 = £21.00m, with no benefit above the cap.
Compared with the outright option, the collar is cheaper but gives up upside; compared with the forward, it preserves some upside while setting a floor near the forward rate. The trade-off is opportunity cost if the euro rallies, plus complexity and credit exposure to the bank. Accounting matters: a collar may not qualify for hedge accounting as easily as a forward, and mark-to-market volatility could hit the P&L. It may still suit Atlantis if the board wants protection around its budget rate without paying £0.367m cash. A zero-cost collar can be tailored so the floor matches the budget rate; the cap should be set at a level the company is genuinely happy to accept. Document the policy before dealing.
3. The contract is only 70% likely to be confirmed within 60 days. How should Atlantis hedge, and what risks arise?
Read the worked answer
With only a 70% probability of confirmation, hedging the full €24m forward would create an overhedge. If the contract fails and the euro strengthens, Atlantis would lose on the forward with no receivable to offset it - a speculative position that could breach the overdraft and covenant. The maximum firm exposure is the probability-weighted amount, but probability weighting alone is not a hedge; it is an expected value.
A better approach is to hedge the confirmed portion, or use options on the full amount and forwards only on the firm part. For example, cover €16.8m (70%) forward and buy options on the remaining €7.2m, or use a conditional forward that only becomes effective if financing is confirmed. Revisit at the 60-day milestone. The hedging policy should state: up to 100% of confirmed commitments, 50–70% of highly probable exposures, and no naked derivatives. Also check that the bank's credit line can accommodate the hedge and that the contract permits cancellation payments. If the contract fails, the option premium is the maximum loss, which is known and affordable.