1

I've never used hedging instruments to do anything other than day trade! :O

Say today I am in the US and I literally borrow AUD $100,000 from a friend in Australia.

She wires it along and I convert it to USD, getting $71,050 today.

I invest it in a donut shop or such and twelve months from now on this date in 2021...

I have to wire her AUD $100,000.

Of course, it could be that at that time one needs say USD 85,000 to get AUD 100,000. (Or it could be worse, or better.)

(This sort of thing must happen constantly on a larger scale commercially, I guess.)

In that actual example of Bruce from Melbin' sending AUD100,000 to Jack in SoCal ...

what literally should Jack do at his brokers to protect or hedge for when the time comes (12 months) to send back the AUD100k?

What specific instruments would I buy, when, for an example how much, in the example given?

  • Sounds like the purpose of currency ETF's but I'm not sure how well they work, FXA is AUD/USD – Hart CO Jul 26 at 19:38
  • Thanks, will investigate I'm really not familiar with currency ETFs – Fattie Jul 26 at 19:52
  • I'd surmise that you'd have to weight the cost of the hedge versus how much you think that the exchange rate might vary and decide if the hedge is going to be ... cost effective but that's based on an understanding of equity options not Forex. A starting point might be Investopedia which has some articles on Forex options. – Bob Baerker Jul 26 at 20:06
  • Indeed, I've never bought a "forex option", and don't know what they are called, where you buy them, which series I would want, etc! – Fattie Jul 26 at 21:45
2

You could buy 10 calls on FXA (the Australian currency ETF mentioned by Hart CO) expiring in 12 months. Each share of FXA approximately tracks the value of AUD100, and 10 calls correspond to 1,000 shares.

The choice of strike price is a tradeoff of how much you want to spend on hedging and how much risk you are willing to take. A higher strike costs less but AUD would be able to rise more at your expense before your protection kicks in.

In your scenario, you face a real problem: If you have little money to spare (which can be presumed since you're resorting to borrowing, and in a foreign currency at that), you fundamentally don't have much room for error if AUD rises sharply. You are funding your US business by effectively taking on a large AUD short position, which is not really a good idea in the first place.

It would be preferable to find a way to borrow in USD for your business.

Trying to hedge AUD using plain ETFs or futures, without options, can lower your cost in theory but ultimately relies on the ability to borrow in USD (and if you can do that, why mess with AUD at all?). To outright buy 1,000 shares of FXA would cost you the entire amount you borrowed.

To buy a futures contract on AUD 100,000 would require only a fairly small margin deposit up front, but then if AUD goes down, you have marked-to-market losses and have to put in more money. Where does that money come from if you put everything into the business? Maybe this works if the business has some divisible assets you can quickly sell off for cash, and then you end up with a smaller business but a lower USD value of the debt.

| improve this answer | |
  • Thanks for the great answer in the first paragraph! "calls on FXA". Am I looking at the correct instrument? -> marketwatch.com/investing/fund/FXA If so, they are very thin as you'd expect, and there doesn't seem to be anything out 12 months? (Is there perhaps a 6 month limit, or ?) – Fattie Jul 27 at 11:57
  • In the last para .. "To buy a futures contract on AUD 100,000..." I got confused here; to which instrument do you refer ? – Fattie Jul 27 at 11:58
  • @Fattie Yes, that's FXA. The options go out about 9 months (currently to March 2021); it appears this ETF doesn't have longer-term options (known as LEAPS). You could hedge in stages (say 6 months at a time) at a somewhat higher cost. This is the futures contract I refer to. Conveniently, one contract is for AUD 100,000. Only the near months are actively traded, but you can "roll" futures over time and have pretty much the same result as if you bought a long-term future. – nanoman Jul 27 at 12:27
  • gotchya ! one could just buy an option on the CME future ... (with all the usual joys/horrors of very thin options!) – Fattie Jul 27 at 12:35

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.