Issues in Corporate Risk Management - Stick to Objectives; Series on Chart Pattern

Aug, 25, 2004     By Vikram Murarka    0 comments

Case Study 1 - A Dollar-Yen Swap

In this Issue

  • Series on Issues in Corporate Risk Management - Part 2 - Stick to Objectives

Issues in Corporate Risk Management

Keep the Objective in mind. It pays

The definition of proper Objectives is the first step in effective Corporate FX Risk Management. Get your objectives wrong and you are most likely courting trouble. We had taken this up in the Issue dated 28-Mar-04. Having set the correct objectives, the Risk Manager needs to keep them in mind after the Hedge Strategy has been implemented, so as to not be led astray by the market. It pays immensely. 

A conglomerate with a Rupee Balance Sheet had a large foreign currency loan book, 85% of which was denominated in US Dollars. The balance was in D-Marks, Yen and Sterling. Circa 1994-95, the Risk Manager decided to reduce the currency concentration risk and rebalance the loan basket using Currency Swaps. The Objective was clearly defined as Risk Diversification. 

It was decided to swap 10% of the Dollar loans into Yen. The Yen was chosen because interest rates were close to zero as compared to 6.50-6.75% on the USD 6-month Libor, giving a huge interest benefit. Further, the Yen was expected to weaken over a 3 year time frame. The Swap took place in Jan-95 near 100 on the USDJPY Spot.

Case Study 1 - A Dollar-Yen Swap

Almost immediately thereafter, the Dollar dived against the Yen, to hit an all time low of 79.80 in April 1995. There were 3 months of intense agony. The company had never undertaken such a large forex deal. The Board was on the edge. Had the deal gone horribly wrong? The Risk Manager reminded the Board that the objective was Risk Diversification and only 10% of the loan book had been put on the line. Further, the deal had a 3 year tenor.

The market eventually turned around and the danger passed. The Swap came back into money. Now the Board was tempted to square off the trade and book whatever small profit was available. Again the Risk Manager stuck to his guns, saying the Objective was long term Currency Diversification, not short term Trading Profits. The Board backed down and the Swap was allowed to run its course.

The Yen eventually touched 120 in 1997. The company booked a huge currency and interest rate gain of almost $17 million. Those who have been in the market through that period would appreciate how difficult it must have been to steer such a trade through to its end. It is immensely commendable that the Risk Manager did not waver from the Objective, neither in bad times nor in good times.

The gains from the deal (which in itself was well conceptualized), was realized by remaining focused on the Objective.

Vikram Murarka

Chief Currency Strategist at KSHITIJ.COM. Likes to look at the markets from many different angles. Weaves many conventional and unconventional technical analysis techniques and fundamental analysis into a global macro perspective. Likes to take the road less traveled.

Leave a Reply

Dollar Rupee Forecast. Get a Free Trial


01Feb18 #Euro 1.2429: As expected, #Euro is ranged between 1.2475 and 1.2350 even after the FOMC. A break below 1.2…

20 days ago  

31Jan18 #Euro 1.2435: Tonight is crucial. FOMC, State of the Union. Yesterday Mnuchin con...

21 days ago  

#EURJPY if falls towards 130, may pull down USDJPY and EURO in the coming sessions. http...

41 days ago  

#EURJPY if falls towards 130, may pull down USDJPY and EURO in the coming sessions. http...

41 days ago