484 CHAPTER 12. (WHEN) SHOULD A FIRM HEDGE ITS EXCHANGE RISK?
12.2.3 FAQ3: “My Accountant tells me that Hedging has cost me
2.17m. So how can you call this a Zero-cost Option?”
You accountant may have meant either of at least three things. First, she may have
calculated that if you had not hedged, you would have raked in an extra 2.17m.
Stated differently, the ex post sum of all the gains/losses (S ̃T−Ft,T) was –2.17m.
This is sad indeed. But this is hindsight. All you can use, for decision-making
purposes, is aPVcriterion. And this brings us irrevocably back to the diagnosis
that, in light of the zero-NPVproperty of (S ̃T−Ft,T), value stems from positive
interactions, if any. Theex postvalue is just good or bad luck and is useless for
decision making.
Alternatively, your accountant may have meant that the accounts show anex
antecost of 2.17m. This concept is based on the not-infrequent (but misleading)
practice of using spot rates to convertfcA/R’s orA/P’s intohc. If one then hedges,
the actual cash flow differs from the book value, and the accountant hilariously calls
this the cost of hedging. If, at the moment of booking the invoice, translation had
been done at the forward rate, hedging would have entailed no accounting cost nor
gain whatsoever.
Example 12.12
Recall our example in Chapter 5 of a Canadian firm that exportsnzd2.5m worth of
goods. We were discussing an accounting issue: should we translate theA/Rat the
spot rate or at the forward? In that example we compared translation at the spot
rate (0.90) and at the forward (0.88), and then looked at the outcome if the firm
had not hedged. Now we assume the firm does hedge. The cost of goods sold being
cad1.5m, profits then amount to 2.5m×0.88 – 1.5m = 2.2m – 1.5m = 0.7m. But
the operating profit depends on the initial valuation of the A/R, and the balance
(if any) is called the cost/benefit of hedging:^5
usingSt= 0. 90 usingFt= 0. 88- att:
A/R 2,250 2,200
COGS 1,500 1,500
operating income 750 700 - atT:
bank 2,200 2,200
hedging cost (D) or gain (C) 50 — —
A/R 2,250 2,200
Which view is true? We know that hedging is free, in principle, so booking the(^5) In the old example, without hedging, there was a random capital gain. Here the effect is
predictable, so accountants would call this a cost or benefit from hedging rather than a capital
gain. Both are financial (i.e. non-operating) items.