Currency Risk

International commodity trading inherently involves multiple currencies. While most commodities are priced in US dollars, costs occur in local currencies, and buyers may pay in their domestic currency. Managing FX exposure is essential to protecting margins.

Types of FX Exposure

Exposure Categories

Type	Description	Example
Transaction	Known future cash flow in foreign currency	Sale invoice in EUR
Translation	Converting foreign subsidiary results	Brazilian subsidiary P&L
Economic	Long-term competitive position changes	BRL weakens, Brazilian costs fall

Transaction Exposure

TRANSACTION EXPOSURE EXAMPLE
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TRADE:
Buy copper from Chile: $50M (USD)
Sell to Germany: €55M

AT TRADE DATE:
EUR/USD: 1.10
Expected USD receipt: €55M × 1.10 = $60.5M
Expected margin: $10.5M

AT SETTLEMENT (30 days later):
EUR/USD: 1.05 (EUR weakened)
Actual USD receipt: €55M × 1.05 = $57.75M
Actual margin: $7.75M

FX LOSS: $2.75M
Margin reduction: 26%

WITHOUT HEDGE: Significant P&L volatility

Hedging FX Risk

Hedging Instruments

Instrument	Description	Use Case
Forward	Fixed rate for future date	Known exposures
Option	Right but not obligation	Uncertain exposures
Swap	Exchange cash flows	Ongoing exposures
Natural hedge	Match currency receipts/payments	Operating structure

Forward Hedge Example

FX FORWARD HEDGE
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EXPOSURE:
EUR receivable: €55M
Settlement: 30 days
Current spot: EUR/USD 1.10

HEDGE:
Sell €55M forward 30 days
Forward rate: EUR/USD 1.0980
Locked USD: €55M × 1.0980 = $60.39M

OUTCOME:
If EUR/USD at settlement = 1.05:
Physical receipt: €55M × 1.05 = $57.75M
Forward gain: (1.0980 - 1.05) × €55M = $2.64M
Net receipt: $60.39M ✓

If EUR/USD at settlement = 1.15:
Physical receipt: €55M × 1.15 = $63.25M
Forward loss: (1.0980 - 1.15) × €55M = -$2.86M
Net receipt: $60.39M ✓

RESULT: Locked rate regardless of spot movement

Option Hedge Example

FX OPTION HEDGE
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EXPOSURE:
EUR receivable: €55M
Settlement: 30 days
Uncertain if deal will close

HEDGE:
Buy EUR put / USD call option
Strike: EUR/USD 1.08
Premium: 0.5% = $275,000
Protected floor: €55M × 1.08 = $59.4M

SCENARIOS:

If EUR/USD = 1.05 (EUR weak):
Exercise put, sell at 1.08
Receipt: $59.4M - $0.28M premium = $59.12M

If EUR/USD = 1.15 (EUR strong):
Let option expire
Receipt: €55M × 1.15 = $63.25M - $0.28M = $62.97M

If deal doesn't close:
Option expires
Maximum loss: $275,000 premium

BENEFIT: Protection with upside participation
COST: Premium paid

FX Policy Framework

Hedging Policy

FX HEDGING POLICY
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HEDGE RATIOS BY CERTAINTY:

CONTRACTED (signed deal):
100% hedge immediately
Instrument: Forward

COMMITTED (high certainty):
75-100% hedge
Instrument: Forward or collar

ANTICIPATED (forecast):
50-75% hedge
Instrument: Options

BUDGET/LONG-TERM:
0-25% hedge
Instrument: Options or none

EXAMPLE:
Trade with €55M receivable (contracted)
Policy: 100% hedge
Action: Sell €55M forward immediately

Approved Instruments

Instrument	Approval Level	Purpose
Spot	Trader	Settlement
Forward (< 1 year)	Trader	Transaction hedge
Forward (> 1 year)	Desk Head	Long-term hedge
Options (vanilla)	Trader	Transaction hedge
Options (exotic)	CFO	Special situations

FX Exposure Management

Exposure Calculation

FX EXPOSURE REPORT
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CURRENCY EXPOSURE (USD equivalent):

Currency    Receivables  Payables    Net       Hedge    Open
────────────────────────────────────────────────────────────
EUR         $120M        $30M        +$90M     $85M     $5M
GBP         $45M         $15M        +$30M     $28M     $2M
BRL         $10M         $25M        -$15M     $12M     -$3M
AUD         $60M         $20M        +$40M     $38M     $2M
CNY         $80M         $10M        +$70M     $60M     $10M

TOTAL NET EXPOSURE: +$215M
HEDGED: $223M
OPEN EXPOSURE: $16M

POLICY: Max 5% unhedged
CURRENT: 7.4% - BREACH ⚠️

ACTION: Increase EUR and CNY hedges

Rolling Hedge

ROLLING HEDGE PROGRAM
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EXPOSURE: Ongoing EUR receipts ~€20M/month

LAYERED HEDGE APPROACH:
Month 1-3: 100% hedged
Month 4-6: 75% hedged
Month 7-12: 50% hedged
Beyond: 0% hedged

CURRENT HEDGE BOOK:
Month     Exposure    Hedged      Rate
Jun       €20M        €20M        1.0850
Jul       €20M        €20M        1.0820
Aug       €20M        €20M        1.0780
Sep       €20M        €15M        1.0750
Oct       €20M        €15M        1.0720
Nov       €20M        €10M        1.0700
Dec       €20M        €10M        1.0680

ROLL SCHEDULE:
Each month: Add new hedge for month 12
Adjust intermediate months as needed

Natural Hedging

Matching Exposures

NATURAL HEDGE STRATEGY
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TRADITIONAL:
Revenue in EUR → Convert to USD
Costs in EUR → Pay in EUR
Net: EUR exposure on revenue

NATURAL HEDGE:
Revenue in EUR → Keep in EUR account
Costs in EUR → Pay from EUR account
Net: Reduced EUR exposure

EXAMPLE:
EUR revenue: €100M/year
EUR costs: €40M/year
Net EUR exposure: €60M (vs €100M without matching)

BENEFIT:
Saves 40% of FX transaction costs
Reduces forward hedging need

Operational Matching

OPERATIONAL NATURAL HEDGE
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STRUCTURE:
Brazilian trading desk
Revenue: USD (commodity sales)
Costs: BRL (local operations)

TRADITIONAL APPROACH:
Convert USD to BRL as needed
Exposed to BRL strengthening

HEDGED APPROACH:
Sell BRL forward to match expected costs
Lock in BRL cost in USD terms

NATURAL HEDGE:
Source some inputs in BRL
Reduces net BRL cost exposure

FX Risk Measurement

FX VaR

FX VAR CALCULATION
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NET EUR EXPOSURE: $90M (long EUR)

EUR/USD VOLATILITY: 8% annualized
Daily vol: 8% / √252 = 0.5%

1-DAY VAR (95%):
$90M × 0.5% × 1.645 = $740,250

10-DAY VAR (95%):
$740,250 × √10 = $2.34M

INTERPRETATION:
95% confident that 10-day FX loss ≤ $2.34M

Sensitivity Analysis

FX SENSITIVITY REPORT
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OPEN POSITION: +$16M net long foreign currency

BREAKDOWN:
EUR: +$5M
GBP: +$2M
CNY: +$10M
BRL: -$3M
AUD: +$2M

SENSITIVITY (±10% move):

Currency    Position    +10%         -10%
────────────────────────────────────────────
EUR         +$5M        +$0.5M       -$0.5M
GBP         +$2M        +$0.2M       -$0.2M
CNY         +$10M       +$1.0M       -$1.0M
BRL         -$3M        -$0.3M       +$0.3M
AUD         +$2M        +$0.2M       -$0.2M
────────────────────────────────────────────
TOTAL       +$16M       +$1.6M       -$1.6M

Key Takeaways

1. Commodity trading involves FX risk — Multiple currencies in every deal
2. Hedge committed exposures — Forward for certainty, options for uncertainty
3. Match where possible — Natural hedging reduces costs
4. Policy drives consistency — Hedge ratios by certainty level
5. Monitor open exposure — Limits on unhedged positions
6. FX can materially impact margins — Don’t underestimate

References

• BIS Triennial FX Survey
• CME Group FX Products
• Hull, John. “Options, Futures, and Other Derivatives”
• Corporate Treasury Best Practices