Once a company with foreign exchange risks has decided to lift or reduce hedging percentages as part of their risk management strategy, value-enhancing market dealing tactics to get the hedging entered at more favourable exchange rates will add to the overall hedging performance.

I have always been a strong advocate of using FX orders placed with bank counterparties as a preferred method of entering hedging than just dealing at the prevailing spot market rate at the time the “go” decision button is pushed. However, it pays to be highly disciplined in placing orders to deal at a predetermined rate , as it is with all aspects of currency management. FX order can either be “firm” (i.e. automatically transacted by the bank once the market spot rate reaches the order level) or “call first” where the bank dealer must call the company once the order level is reached and get prior confirmation before transacting. Firm orders can either be “good until cancelled” or left in place until a stipulated time. It is important for control purposes that the company has a register of FX orders placed with all banks with a record of transacted. lapsed or cancelled.

I have also been a fan of a staggered series of orders for different amounts at selected exchange rates. Of course, the big risk in using orders to transact hedge entries is that the market rates never get to the order levels, move in the opposite direction and the hedging is never done!

Many companies use a second “stop-loss” order above or below the order placed. In this way, the hedging is transacted whether market exchange rates move up or down. The instruction to the bank in using stop losses has to be an explicit “either/or”, the transaction is either dealt at the order level or the stop-loss level and when that happens the second order automatically cancels.

Like a lot of things in currency management, judgment is required of how close to place the order and related “stop-loss” to current market rates. That judgement depends on short-term exchange rate volatility, technical support and resistance levels and the skill of the bank dealer being used. Companies transacting hedging in this way have to accept that there will be times when the stop-loss is triggered and a less than optimal entry is achieved. Constant monitoring is required, however I have never found the changing of order/stop-loss levels on a regular basis, once placed, is too value-enhancing. Set the targets and stick to them. Understand the risks if you place an order at a more favourable rate without a related either/or stop-loss on the other side.  For currencies that make their more significant movements in overnight markets, judicious use of FX orders makes a lot of sense.

Roger Kerr is widely regarded as one of New Zealand’s leading professional advisers and commentators on local/international financial markets, the New Zealand economy and corporate treasury risk management. Roger has over 30 years merchant and investment banking industry experience, and has been closely associated with the changes and development of New Zealand’s financial markets since 1981. Roger advises many Australian and New Zealand companies in the specialist areas of foreign exchange risk, interest rate and funding risk and treasury management policy/governance matters.

Roger has provided daily market and economic commentary on the 6.40am slot at radio station NewstalkZB since 1994. 

It always surprises me with treasury management how much changes and yet how much stays the same. Having been in the treasury game for almost 25 years the basics remain the same – it’s all about risk management stupid. And by risk management I really mean risk minimization. The hedging instruments haven’t changed very much over the years. We still favour the plain vanilla of forwards, swaps and options. Sure the exotic instruments have come and gone and some have learnt the hard way about understanding what you are getting into, but even large organisations favour the simple approach, especially after the events of the last few years.

The basic controls surrounding treasury haven’t changed much either, even if not everyone complies the way they should. No – you can’t do the deal, check the bank confirmation and then provide the reporting as well. And, yes you should have a treasury policy too outlines the rules you have to abide by (identify your exposures and have sensible parameters about when and how much you should cover.)

What has changed though, and not just in the treasury space, is those small and medium enterprises (SME’s) now have access to the same tools and the same technology that larger organizations have, at an affordable price.  Going back not so long, treasury management systems were expensive and the domain of only the very large organizations.

In more recent years we have seen a number of mid-tier systems come to market, many of which are saas (software as a service) solutions giving access to valuations, smart reporting and increasing the controls around the foreign exchange and interest rate management.

No longer can organizations argue that spreadsheets are their only option. Sure spreadsheets are great but we all know the issues with them – lack of controls, key man risk, backups, corruption of data, the list goes on. But everyone uses them for the flexibility and there is still a place for them when it comes to specific reporting reqirements. However now that there are systems like Hedgebook available, “SME” sized organizations have access to the tools that will allow then to record, report and value their treasury transactions and can manage their treasury exposures with the same technology and confidence that much larger organisations can – at an affordable price.

Because there’s one other thing that hasn’t changed over the years and that is financial markets are volatile and so knowing your position with confidence is the most important part of good risk management – and that won’t change either.

Richard Eaddy is the CEO and founder of Hedgebook and the Managing Director of ETOS Ltd, specialists in treasury outsourcing services. Richard has worked in the corporate treasury risk management industry for more than 20 years. He has held senior roles in large corporate treasury departments in both New Zealand and Europe, provided treasury risk management advice to major corporations and for the last ten years has headed up the largest treasury outsourcing company in Australasia. Richard can be contacted at


Very interesting to see what is going on in the UK regarding the mis-selling of swaps to small businesses.

This article in The Telegraph talks about the FSA’s potential sanctions against the four major banks and the growing discontent amongst those now facing significant financial loss.

Martin Wheatley told MPs the UK's largest banks had "questions to answer" over their sale of interest rate swap to SMEs (courtesy of The Telegraph)

“The FSA’s review followed an investigation by The Sunday Telegraph and The Daily Telegraph, which uncovered evidence of widespread mis-selling of complex interest rate derivatives by banks.”

This once again highlights the perils of placing 100% trust in your bank’s advice when it comes to hedging any type of financial risk.  Whether you are looking to mitigate exposure against interest rate shifts or currency fluctuations you should only enter into derivative transactions that you fully understand and that you can explain to your Board.

This echoes the warnings in Richard Eaddy’s recently-published report “7 things your bank won’t tell you about currency hedging”.  You can download this free report here

This unfortunate situation also clearly demonstrates the necessity of knowing the value of your swaps (or any derivative transaction), so that when the unexpected happens, you are fully aware of the implications on your position and are prepared to act accordingly.

If only they had been using Hedgebook…

Swap Curve

In the final article in this series, we will continue to build out our discount factor curve using longer datedpar swap ratesPar Swap rates are quoted rates that reflect the fixed coupon for a swap that would have a zero value at inception.

Let look at our zero curve that we have built so far using LIBOR rates.

zero curve

We are now going to build out this curve out to 30 years using par swap rates. These rates are as of Nov 10, 2011, and reflect USD par swap rates for semi-annual LIBOR swaps. The daycount convention is 30/360 ISDA.

par swap rates

Also keep in mind that these rates reflect the settlement conventions, so the one year rate is for an effective date of Nov 14, 2011 and termination of Nov 14, 2012. If we were to price a one year swap from the curve we have built so far, we can derive the 6mo discount factor, but we are currently missing the 1year factor. Since we know the swap should be worth par if we receive the principal at maturity, then the formula for a one year swap is:

1 year par swap rate resized 600

Notice that the T’s would be adjusted for holidays & weekends and are calculated using the appropriate discount factor. We can rearrange our formula to solve for df(1year).

swap bootstrapping

Using our example data:

discount factor par swap

We calculate the missing discount factor as: 0.99422634. But, this for a swap which settles on November 14th, and we are building our curve as of November 10th. So we need to multiple this by the discount factor for November 14th to present value the swap to November 10th. So the discount factor we use in our curve for Nov 14, 2012 is 0.9942107.

We continue by calculating discount factors for all the cashflow dates for our par swap rates. The next step is to calculate the discount factor for May 14, 2013. Our first step is to calculate a par swap rate for this date as it is not an input into our curve. We linear interpolate a rate between our 1 year and 2 year rates.

1.5 year par swap rate = 1 year + (2 year – 1 year)/365 x days

= .58% + (.60%-.58%)/365 x 181 = 0.589918%

We now can solve for the missing discount factor, continuing our bootstrapping through the curve.

zero curve construction

Thanks to our sister company Resolution for providing us with this series of posts.

Zero Curve

In the previous articles we described basic swap terminology, created coupon schedules and calculated fixed and floating coupon amounts. We also present valued our cashflows and calculated forward rates from our Zero Curve. A zero curve is a series of discount factors which represent the value today of one dollar received in the future.

In this article we are going to build up the short end of our discount factor curve using LIBOR rates. 

Here are the rates we are going to use. They represent USD Libor as of November 10, 2011.































Our first step will be to calculate the start & end dates for each of our LIBOR. Our TN settles in one day, and the other rates all settle in two days. We also will need to calculate the exact number of days in each period. Keep in mind that November 12th was a Saturday so our TN rate ends on the Monday, November 14th.

libor curve

Our formula for converting rates (simple interest) to discount factors is

simple interest discount factor

Where R is our LIBOR rates and T is our time calculated by the appropriate daycount convention, which in this case is Actual/360.

So our first discount factor reflecting the overnight rate is:

overnight rate

which equals: 0.999996083348673.


For our subsequent rates, they settle in the future. So when we calculate their discount factors, we will need to discount again from their settle date. See the image below to see the time frame each rate represents.

zero curve bootstrapping

Because we need the previous discount factors to calculate the next discount factor in our curve, the process is known asbootstrapping.

To calculate the discount factor for TN:


Which equals; 0.999988250138061 x 0.999996083348673 = 0.999984333532754

We continue the process for each time period, to build up the short end of our curve.

libor discount factors

We have shown how to convert LIBOR rates into a discount factor curve, while taking into consideration the settle dates of the LIBOR rates.

Thanks to our sister company Resolution for providing us with this series of posts.

Next Article: Building the long end of the curve using Par Swap Rates.

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