Hedgebook helps with

Commodities such as base and precious metals are equally volatile as exchange rates and interest rates. Producers of commodities as well as users of commodities are exposed to movements in commodity prices and can choose to hedge via a number of financial instruments. Most common are forwards, swaps and options (including Asians).

How Hedgebook helps:

Hedgebook can record, report and value a broad selection of base and precious metals. Forwards, swaps and options are all accommodated.

In the post GFC environment, greater focus has been given to the impact of counterparty credit risk. The notion of counterparty credit risk is defined by the risk that a party to a financial contract will fail to fulfil their side of the contractual agreement.

Under IFRS 13, both Credit Value Adjustments (CVA) and Debit Value Adjustments (DVA) need to be calculated dependent on whether the financial instrument is an asset or a liability:

  • CVA is the credit adjustment for a derivative that is “in-the-money” i.e. an asset, and reflects the credit risk of the counterparty (likely the bank).
  • DVA is the credit adjustment for a derivative that is “out-of-the-money” i.e. a liability, and reflects the own credit risk of the reporting entity.

When considering credit risk there are a number of factors that can influence the valuation including:

  • time: the longer to the maturity date the greater the risk of default
  • the instrument: a forward exchange contract or a vanilla interest rate swap will carry less credit risk than a cross currency swap due to the exchange of principal at maturity
  • collateral: if collateral is posted over the life of a financial instrument then counterparty credit risk is reduced
  • netting: if counterparty credit risk can be netted through a netting arrangement with the counterparty i.e. out-of-the money valuations are netted with in-the-money valuations overall exposure is reduced.

There are numerous methodologies when considering the calculation of CVA/DVA with the appropriate methodology determined by the size and sophistication of the entity’s holding of derivatives.

How Hedgebook helps:

Hedgebook has a CVA/DVA module to keep the auditor happy. In line with the Hedgebook “demographic” we have deliberately kept the CVA module towards the simpler end of the CVA calculation spectrum. We use the current exposure method which we feel is appropriate for vanilla instruments such as FX forwards, FX options and interest rate swaps for an entity using these instruments for hedging purposes.

The module is broken into the following steps:

  • Creating new credit curves (both for the counterparty to the transaction and the company’s own credit).
  • Managing previously created credit curves
  • Assigning credit curves to instruments
  • Running the CVA/DVA report

An exporter is a company based in one country and selling goods/services to another. Often payments for the goods/services are received in a different currency to the base currency of the exporter. As such an FX exposure is created and profits are impacted by the fluctuations of exchange rates.

There are a number of risk management approaches used to manage the impact of foreign exchange movements. Some exporters will adopt a “no hedging” approach; perhaps the cost of producing the good/service is correlated with FX rates so the negative impact of FX on cost of goods sold is offset by higher sales proceeds. Some exporters will hedge on a shipment by shipment basis so the margin is locked in. Some exporters will manage FX on a forecast exposure basis to achieve stable receipts in local currency terms.

The most common financial instruments used by exporters are FX forwards and FX options.

How Hedgebook helps:

Hedgebook provides total visibility of the exporter’s hedging position. By capturing cashflows, hedging and market exchange rates, exporters can understand their position and the impacts fluctuating exchange rates can have on profits.

Fair value and mark-to-market relates to the valuation of a financial instrument as measured against the prevailing market conditions at a given date. Companies with financial instruments such as FX forwards, options and interest rate swaps are required to provide a fair value at financial year-end, especially if reporting under IFRS. Positions are also “marked” through the year at key dates such as month-end for management reports. Fair values impact on the credit available to enter new derivatives with counterparties. Fair values can be positive or negative depending on whether the market has moved favourably or not since the date the transaction was entered into.

How Hedgebook helps:

Hedgebook’s daily rate feeds enables users to access independent valuations removing the reliance on banks for provision of fair values. Hedgebook’s rate feeds are sourced from industry benchmark sources.

Financial instruments cover a broad range of tradable assets. They range from the vanilla to the exotic and are used for a broad range of reasons. Financial instruments are used for both hedging and speculative purposes. From a Hedgebook perspective, financial instruments covered are at the vanilla end of the spectrum used by companies to hedge their underlying exposures. Importers and exporters will use financial instruments to hedge their foreign exchange risks. Borrowers will use financial instruments to hedge the interest rate exposure on debt.

How Hedgebook helps:

Hedgebook’s universe of financial instruments is focussed at the most common ones used by companies to hedge their FX, interest rate and commodity exposures:

  • FX forwards
  • FX options
  • Interest rate swaps (including amortising)
  • Base and precious metals forwards, options and swaps

An FX forward is a commitment to exchange an agreed amount of two currencies at a future date. An FX forward will have a different exchange rate to the spot rate and the difference in the two rates is the forward points. Forward points are the time value adjustment made to the spot rate to reflect a future date. Forward points are mathematically derived by the prevailing interest rate markets.

How Hedgebook helps:

Hedgebook is used to record, report and value FX forwards. The valuation of an FX forward clearly shows the spot rate and forward rate that is used in the calculation.

FX, or forex, hedging is the mitigation of the impact of exchange rate fluctuations. The profitability of importers and exporters is at risk from movements in exchange rates and many enter into financial instruments such as FX forwards and FX options to minimise, or remove, the impact.

How Hedgebook helps:

Hedgebook is a low-cost system to record, report and value FX instruments such as FX forwards and options. Hedgebook has functionality to help importers and exporters make better FX hedging decisions. Hedged rates are clearly visible and “what-if” scenarios quantify the P&L impact of fluctuating exchange rates.

FX options are an alternative hedging instrument to forward contracts. Options give more flexibility and are often used where there is a lower level of certainty in the expected exposures, or if there is a poor track record in the accuracy of forecasts for actual exposures. There is a cost to purchasing an option, called premium, and is akin to the premium on an insurance policy. The owner/holder/purchaser of an option has all of the rights to exercise the option but is not obligated to do so. If at maturity the option is “in-the-money” the option is exercised. If the option is “out-of-the-money” the owner of the option will choose not to exercise the option.

How Hedgebook helps:

Hedgebook is used to record, report and value FX options, including the split between time and intrinsic value. The valuation of an FX option clearly shows the spot rate, forward rate and volatility used in the calculation.

The fluctuation of exchange rates, or volatility, is the fundamental reason importers and exporters hedge foreign currency exposures. Although payments or receipts may not change in foreign currency terms, volatility in exchange rates can result in material impacts of such payments or receipts in local currency terms. A measure of FX volatility is a fundamental input into the pricing and valuation of FX options.

How Hedgebook helps:

Hedgebook is used to record, report and value FX options, including the split between time and intrinsic value. The valuation of an FX option clearly shows the spot rate, forward rate and volatility used in the calculation.

Hedge accounting is designed to reduce the impact on P&L from the unrealised mark-to-market of derivatives. By following some key rules around the appropriate documentation and measurement of the hedge and the hedged item, the unrealised mark-to-market can sit on the balance sheet.

How Hedgebook helps:

Hedgebook’s valuations can be used in the effectiveness testing requirements of hedge accounting and is used by a number of public and private companies to achieve this.

IAS39 is the International Accounting Standard that relates to the recognition and measurement of financial instruments. It is the standard that provides guidance on hedge accounting and will be replaced by IFRS 9 from 1 Jan 2018.

How Hedgebook helps:

Hedgebook’s valuations can be used in the effectiveness testing requirements of hedge accounting and is used by a number of public and private companies to achieve this.

The objectives of IFRS 13 are to provide:

  • greater clarity on the definition of fair value
  • the framework for measuring fair value
  • the disclosures required about fair value measurements.

How Hedgebook helps:

Hedgebook’s daily rate feeds enables users to access independent valuations removing the reliance on banks for provision of fair values. Hedgebook’s rate feeds are sourced from industry benchmark sources and its methodology is in line with IFRS 13 requirements.

IFRS 9 is the replacement of IAS 39 and comes into effect from 1 Jan 2018 (can be adopted early). IFRS 9 attempts to simplify hedge accounting. The 80% to 125% bright line test is removed which means that only the ineffective portion of a hedge goes to P&L if the hedge is deemed to fall outside of the parameters. The need to separate time and intrinsic value of an FX option is also removed.

How Hedgebook helps:

Hedgebook’s valuations can be used in the effectiveness testing requirements of hedge accounting and is used by a number of public and private companies to achieve this.

An importer is a company based in one country and receives goods/services from another. Often the goods/services are paid in a different currency to the base currency of the importer. As such an FX exposure is created and profits are impacted by the fluctuations of exchange rates.

There are a number of risk management approaches used to manage the impact of foreign exchange movements. Some importers will adopt a “no hedging” approach; perhaps FX costs can be passed on to the consumer or competitors do not hedge. Some importers will hedge on a shipment by shipment basis so the landed cost of goods is known. Some importers will manage FX on a forecast exposure basis to achieve a stable cost of goods over time.

The most common financial instruments used by importers are FX forwards and FX options.

How Hedgebook helps:

Hedgebook provides total visibility of the importer’s hedging position. By capturing cashflows, hedging and market exchange rates, importers can understand their position and the impacts fluctuating exchange rates can have on profits.

Interest rate hedging is the mitigation of interest rate risk. For a borrower, interest rate hedging is achieved by entering financial instruments to protect against increasing interest rates. The most common instrument is an interest rate swap, although options such as caps and collars are also used.

How Hedgebook helps:

Hedgebook is used to record, report and value interest rate swaps.

Interest rate swaps

An interest rate swap exchanges one set of cashflows for another. The simplest example is a borrower who has borrowed on a floating rate basis but who wishes to fix their interest rate costs. In this example the borrower will enter a pay fixed swap which means they will pay an agreed fixed amount on a regular (monthly/quarterly/semi-annual) basis and in exchange receive a floating rate amount. The received floating amount will offset against the paid floating amount on the underlying debt. The net effect is the borrower paying fixed.

There are many uses for interest rate swaps with the above example the simplest and most common for Hedgebook users.

How Hedgebook helps:

Hedgebook is designed to capture, value and report interest rate swaps, including amortising structures. The daily rate feed of floating rate references such as BKBM and BBSW simplifies the valuing, administration, control and compliance of these financial instruments.

The foreign exchange market is dynamic. Exchange rates change every second of every day and movements can be large and swift. As a company exposed to exchange rates it is important to have visibility and understand the impacts of exchange rates on the business.

How Hedgebook helps:

Hedgebook Data gives users access to live FX spot and forward rates. Always be up to date with market movements.

When a company uses FX forwards to hedge future foreign currency exposures, often the hedge contract needs to be adjusted to reflect the actual timing of the cashflows as they fall due. FX forwards are often brought forward (pre-delivered) or pushed out (extended) to align with actual cashflows. This can be for the full amount or part of the amount.

How Hedgebook helps:

Hedgebook has a pre-delivery and extension wizard to make life easy, allowing the user to manage pre-deliveries and extensions in a simple and straightforward way.

The floating leg of an interest rate swap is “rate-set” against the relevant benchmark as defined in the signed agreement between the two counterparties. In New Zealand the rate-set is managed by the NZFMA and is termed BKBM. In Australia it is managed by AFMA and is termed BBSW. Globally the most prevalent rate-set is LIBOR and is managed by ICE (following the scandal that surrounded LIBOR when it was managed by British Bankers’ Association (BBA))

How Hedgebook helps:

Hedgebook’s daily rate feeds of underlying floating rate references such as BKBM and BBSW enables the automatic calculation of cashflows to ease the administration of interest rate swaps.

Despite the flexibility of spreadsheets we all know they are error-prone and often inadequate to manage financial market risks appropriately. Spreadsheets represent a significant risk to businesses when relied on as the sole mechanism to record and report treasury derivatives such as FX forwards, FX options and interest rate swaps.

How Hedgebook helps:

Hedgebook’s low cost system offers an alternative to spreadsheets at a palatable price point. Using a system allows companies to move away from relying on spreadsheets and mitigates the risks, inefficiencies and inadequacies of spreadsheets. However, we still recognise the importance of spreadsheets so Hedgebook retains upload and download connectivity.

Risk management in a treasury sense is the mitigation of the negative impacts of the financial markets on a company’s profits. The appropriate risk management approach is shaped by a company’s risk appetite and the competitive landscape it operates within. Financial instruments such as FX forwards, FX options and interest rate swaps are used every day by companies managing foreign exchange and interest rate risk. Profits can be significantly impacted by volatile financial markets on unhedged exposures.

How Hedgebook helps:

Hedgebook’s online system records, reports and revalues FX and interest rate derivatives removing reliance on error prone spreadsheets. Combining your foreign exchange hedges, cashflows and live exchange rates Hedgebook gives total visibility over your position and the impact exchange rate movements will have on your business. Actual position versus policy limits is always visible.

Accounting standards prescribe certain disclosures that are required for financial reporting. For financial instruments, IFRS 7 requires revaluations under certain hypothetical market movements. From an FX perspective it is often a +/-10% movement in the prevailing market rates that is recorded in the notes to the accounts. From an interest rate perspective it is often +/-100bp parallel move in the curve.

How Hedgebook helps:

Hedgebook re-calculates the fair value of a user’s portfolio of FX and interest rate derivatives across a number of alternative hypothetical movements in the underlying market data as required under IFRS 7. Hedgebook simplifies financial year-end compliance.

In Hedgebook’s universe swap rates relate to the fixed rate of an interest rate swap. The interest rate swap market is very deep and liquid. Swaps are used by a large number of companies and banks to manage interest rate exposure. A swap rate can simply be viewed as the market’s expectation for floating rates over different terms. For example, a two year swap rate of 4% is the market’s expectation that floating rates will average 4% over the next two years.

How Hedgebook helps:

Hedgebook is used to record, report and value interest rate swaps.

The valuation of an FX option is made up of time value and intrinsic value. The intrinsic value of an FX option is the difference between the prevailing market forward rate for the expiry of the FX option versus the strike price. The time value of an FX option is the difference between the overall FX option valuation and the intrinsic value. By definition, time value is a function of the time left to the expiry of the FX option. The longer the time to expiry, the higher the time value as there is a greater probability of the FX option being exercised. If a company is hedge accounting FX options the time and intrinsic value must be separated. Intrinsic value can stay on the balance sheet but time value must be accounted for through the P&L.

How Hedgebook helps:

Hedgebook is used to record, report and value FX options, including the split between time and intrinsic value.

Treasury Management Systems help organisations manage their treasury risks such as interest rate and foreign exchange exposures. Treasury systems remove reliance on error-prone spreadsheets and provide controls and compliance that are hard to achieve otherwise. Historically, Treasury Management Systems have been the domain of large organisations with large treasury exposures. The system was deployed into the organisation’s environment and was expensive and cumbersome.

With cloud based applications, small to mid-sized companies can now benefit from the use of Treasury Management Systems at palatable costs. Treasury exposures are just as material to a smaller organisation’s profitability as they are to a larger organisation and now the playing field is levelled by the introduction of low-cost systems delivered over the internet. No more complicated deployment or long lead times for upgrades.

How Hedgebook helps:

Hedgebook’s low-cost, on-line Treasury Management System allows small and mid-sized companies to increase risk management rigour and compliance to FX, interest rate and commodity exposures.

Treasury risk management relates to the management of risks arising from foreign exchange, interest rate and commodity prices. A range of tools and financial instruments are available. Some companies will have a formal Treasury Policy that is a Board approved document that outlines what risks are being managed and how they should be managed. For smaller companies there is unlikely to be a formal policy document however it is still important that exposures to financial markets are recognised, calculated and mitigated.

How Hedgebook helps:

Hedgebook’s low-cost, on-line Treasury Management System allows small and mid-sized companies to increase risk management rigour and compliance to FX, interest rate and commodity exposures.

A zero curve is a series of discount factors which represent the value today of one dollar received in the future. A zero curve is mathematically constructed using a series of short and long term market interest rates such as futures and swaps. The zero curve is applied to financial instruments such as interest rate swaps to discount expected future cashflows back to a present value.

How Hedgebook helps:

Hedgebook’s proprietary models construct zero curves to provide independent valuations of financial instruments.