More Examples as Why Hedging is Important

Two weeks ago, in a post entitled To Hedge or Not to Hedge, we argued that it’s always important for corporations to hedge the commodity prices and not to speculate. This post continues with more examples that highlight the importance of economic hedging.

As oil price fluctuates, airlines can see their revenue vary widely. They can reduce the revenue volatility by hedging the fuel costs

Globally, risk managers quote Southwest Airlines’ long running (25 years) and successful corporate hedging programme, which makes up one-third of their costs. Ryan Air remains one of the latest examples of having hedged their exposures to the extent of 95% in 2017, having declared price certainty as their target than low prices. Singapore Airlines Ltd, remains another south-east Asian airline that has currently reported to have extended its hedging horizon from the previous 2-5 years hedging an average of 37% of its total fuel cost. Meanwhile, Malaysian Airlines has taken a prudent approach in the current oil price environment and has aggressively hedged 65% of their fuel oil requirements for 2017 at about a bit north of $60/bbl. While hedging is catching up as a healthy practice to protect the bottom lines among airline firms globally it is yet to catch up in World’s ninth largest civil aviation market—India, where the cost of fuel for an airline fluctuates widely from 28% to 63% of its total operating expense. Read more

Recently, the French election has caused some uncertainties in the market as it was reflected in the term structure of volatility.  As reported by Laura Dew, some portfolio managers did not leave it to chance and hedged their portfolios:

The latest hedge against potential turmoil in Europe employed by TwentyFour is via an option position on a weaker euro versus the US dollar.

With the euro/dollar back up close to $1.08, rather than $1.05 where it has recently been, even a more market friendly French election outcome may not cost money if the US dollar finds some of its prior inertia.

There is no such thing as a free option, but we think this is a cheap way of protecting some downside exposure to an event that may not be as clear cut as the polls suggest. Read more

As the results of increasing political risks in Europe, the corporate credit spreads started widening. Japanese investors took this opportunity to buy European bonds as an alternative to low-yielding domestic bonds. However, they have to hedge the currency risks, as pointed out by Hideyuki Sano:

Because they do not like exposure to foreign exchange fluctuations, they use currency hedging on a large part of their foreign bond investment.

The hedging costs are closely tied to short-term interest rate gaps between currencies and rises in dollar interest rates mean hedging will become costlier for Japanese investors.

On the other hand, because the euro zone’s short-term interest rates are deep into negative territory, hedging for the euro costs almost nothing, or sometimes even produces extra returns. Read more

The above examples provided insights into large corporation hedging programs and clearly demonstrated the importance of hedging.

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