5.8 CASE STUDY: HEDGING A FORECAST SALE AND SUBSEQUENT RECEIVABLE WITH A PARTICIPATING FORWARD
In this case, as in the previous cases, the cash flow stemming from a highly expected forecast sale and its ensuing receivable denominated in a foreign currency are hedged from a hedge accounting perspective. In this case, however, a participating forward is chosen to hedge the FX risk. The participating forward is one of the most basic and conservative hedges available. As its name implies, this hedge provides guaranteed protection, while allowing the entity some degree of “participation” in favourable movements of the EUR–USD exchange rate.
Suppose that on 1 October 20X4, ABC Corporation, a company whose functional currency was the EUR, was expecting to sell finished goods to a US client. The sale was expected to occur on 31 March 20X5, and the sale receivable was expected to be settled on 30 June 20X5. Sale proceeds were expected to be USD 100 million, to be received in USD.
ABC had the view that the USD could appreciate against the EUR in the following months and wanted to benefit were its view right. At the same time, ABC wanted full protection in case its view was wrong. As a consequence, on 1 October 20X4, ABC entered into a participating forward with the following terms:
|FX participating forward terms
|1 October 20X4
|ABC and XYZ Bank
|30 June 20X5
|USD 100 million
|EUR 100 million/forward rate