Twelve months after the forward was dealt the mark is a loss of
8,130,844.04, and the audit committee wants it explained. It is
explicable in one line: the company fixed 109,516,214.78 on
120,000,000.00 of dollars, twelve months in advance, on
66.1376 per cent of EBITDA — and it received 109,516,214.78. The
8,130,844.04 is the value of an outcome the company chose not to have.
A forward is not a forecast
A twelve-month forward is spot adjusted for two interest rates, because the bank on the other
side has to borrow one currency and lend the other for the year. At a spot of
1.0800, a dollar rate of 4.50 per cent and a home rate of
3.00 per cent, the forward is 1.0957 and the forward points
are 0.0157.
At spot, 120,000,000.00 of dollars is 111,111,111.11. At the forward it is
109,516,214.78. The gap, 1,594,896.33, is
1.4354 per cent of the spot value and it is the carry of the hedge: the
interest differential showing up in the price. No bank charges it as a fee. A company with
dollar receipts pays it; a company with dollar payables is paid it. Same forward, same day,
opposite sign.
Three futures, one hedged column
Spot in twelve months
Unhedged proceeds
Hedged proceeds
Hedge gain (loss)
1.0200
117,647,058.82
109,516,214.78
-8,130,844.04
1.0800
111,111,111.11
109,516,214.78
-1,594,896.33
1.1600
103,448,275.86
109,516,214.78
6,067,938.92
The hedged column is the same in every row. That is what a forward does.
The row missing from that table is the break-even, and it is not the spot
the forward was dealt at. It is the forward itself, 1.0957. Only if the
dollar weakens by the full forward points does the hedge break even against doing nothing. At an
unchanged spot the hedge still shows a loss, of exactly the carry,
1,594,896.33. A committee that expects a hedge to break even at an unchanged rate has been
given the wrong break-even.
What the hedge was actually bought for
On the day the forward was dealt nobody knew whether the rate would be
1.0200 or 1.1600. One cent on the rate is
worth 1,019,367.99, which is 0.6068 per cent of EBITDA;
ten cents is 9,416,195.86, or 5.6049 per cent. A rate that can move
ten cents in a year puts 5.6049 per cent of EBITDA at the mercy of a market the
board never discusses. The forward removed that, and its price was the carry, known on the
day.
A hedge is a position on variance, not on direction. The company that hedges is saying it
would rather have 109,516,214.78 for certain than a draw from a distribution centred
somewhere near it. If the draw comes out at 117,647,058.82, the company was still right
to prefer the certainty, for the same reason a building was still worth insuring in a year it did
not burn.
What would have been wrong is a hedge put on as a view — because the treasurer thought
the dollar would weaken — and then defended as insurance when it did not. The distinction
is visible in the paperwork. A hedge put on for the exposure is dealt at the ratio the policy
sets, on the calendar the policy sets, whatever the treasurer thinks of the rate. A hedge put on
as a view is dealt when the rate looks attractive.
Layering, and what it costs
The dollars are not sold on one day. The policy hedges the next four quarters at falling
ratios, so that the rate achieved on any quarter is an average of four forwards dealt three
months apart.
Quarter ahead
Exposure (USD)
Hedge ratio
Hedged (USD)
First
30,000,000.00
100 per cent
30,000,000.00
Second
30,000,000.00
75 per cent
22,500,000.00
Third
30,000,000.00
50 per cent
15,000,000.00
Fourth
30,000,000.00
25 per cent
7,500,000.00
Total
120,000,000.00
62.50 per cent
75,000,000.00
Each quarter the nearest drops off fully hedged, a new fourth quarter is added, and every quarter already in the programme is topped up.
The cost is in the same table. At any moment 45,000,000.00 of dollars is unhedged and the
fourth quarter out is three-quarters open. Layering trades the risk of one bad dealing day for a
permanent partial exposure. The ratios are a policy choice, and a steeper or flatter ladder moves
the 62.50 per cent with it.
The budget rate trap
The annual plan carries a rate, and the divisions were given it to convert their dollar
forecasts. If the budget was set at 1.0800 and the forward is
1.0957, no forward will achieve budget; the carry sees to that. A treasurer told to
protect the budget rate will wait for spot to move in her favour, which is to take a view. A
budget set at spot builds 1,594,896.33 of guaranteed shortfall into the year before
anything has happened, and then blames the treasurer for it. Set the budget at the forward, or at
the achieved rate of the hedges already in place.
Three lines to read on the next hedge report
Discard the mark-to-market as a measure of the programme: it measures the distance between the
forward and where spot went, which is the one thing the hedge was never trying to predict. Read
the rate the hedges fixed and the amount that fixes, 109,516,214.78 on
120,000,000.00. Read the ratio actually in place against the policy ratio,
62.50 per cent on average. And read the value of one cent on what is still open:
1,019,367.99 on the full exposure, 382,263.00 on the
45,000,000.00 left unhedged.
Judge a hedge by whether it fixed what it was meant to fix, never by whether it beat the
spot.
The workbook behind this article
Every figure above is a live formula in the companion files for
Treasury Management — the five readings of cash, the liquidity
test, working capital and the discount, and the hedging book. Each file ends with a Checks
sheet setting the printed figure beside the computed one. They are free, and they need no
account and no email address.
At what wealth does a family office pay?A five-person office costs the same $2,442,000 at $100m as at $2bn. Against a tiered multi-family schedule the two curves cross exactly once.
Does an undrawn revolver count as liquidity?67.4567 per cent of the headroom, and it leaves at a fall in annual revenue of 8.4127 per cent — not the 13.3333 per cent the board deck implies.
Does supply chain finance count as debt?66,049,315 released, and leverage of 2.7622× or 3.1362× depending on which balance the test is asked of — the second is a breach at today's EBITDA.
Does the fulcrum move with enterprise value?A worked capital structure at three enterprise values. The break migrates from the first lien to the subordinated notes without a single document changing.
How many companies does a reserve pool defend?Holding pro rata to the Series D costs $14.76m per company. A $40m reserve defends 2.71 of forty — and 61 per cent of the cost is the last round.
How much room a 1.15x downside actually leaves79 basis points of margin. The leverage covenant fails first, five basis points before the coverage covenant the chapter reports on, and 4.6 per cent of EBITDA is the whole cushion.
How the GP catch-up is actually solvedMost write-ups state the catch-up formula then hardcode the answer. Set it as a solve and it moves on its own when the carry rate does.
How do you set a minimum cash balance?Three components, 124,596,281 in total — and the double count that turns a margin of 27,403,719 into an apparent shortfall of -3,988,281.
Is a 2/10 net 60 discount worth taking?An annualised 14.8980 per cent against a revolver at 4.50 per cent — worth 5,471,890 a year, and 0.3132 turns of reported leverage.
Should corporate debt be fixed or floating?78.1818 per cent of gross debt fixed, and a net floating exposure after cash of -608,000.00 — the proportion, not the instrument.
Six ways to state the same fund's return7.12 per cent, 18.04 per cent, or 1.323 times the public market — one fund, one set of flows. The eleven-point gap is the valuation, and it is not cash.
The IRR at which a closed-ended fund merely tiesA drawdown fund advertising 13.25 per cent ties an evergreen netting 8.64. On committed rather than called capital, 78.7 per cent of the edge vanishes.
The month a remediation trigger has to be armed byMonth 8, on a one-year window and a 14-week hiring lead time. The date is 12W − L/4.33 and holds for any portfolio size — the book only changes the euros.
Two routes to the same NAVFive findings in one quarter-end close, and not one of them was a modelling error. Every one was a control that did not exist.
What a CBAM certificate buffer costs to holdCarry and protection are both linear in the buffer, so the break-even probability is identical at 5 per cent and at 30 — and 2027 costs exactly twice 2026.
What a clawback actually collateralises24 million recovers 13.20 net of tax and 7.20 is escrowed. The rule is e ≥ 1 − t, and every euro won on the tax clause lands uncollateralised.
What a co-investment programme actually saves37 basis points, and a 22.8 per cent total-loss rate erases it. At the usual per-deal cap a single failure is 37 per cent of the annual cohort.
What a diligence exercise actually recoversEighteen basis points is only the part that reaches the yield. Three of the four instruments never do, and the exercise is worth thirty-one.
What a follow-on reserve is actually worth0.019 turns under plain dilution, 0.285 under pay-to-play. The optimum is a property of the shareholders’ agreement, not of the portfolio.
What a lease mark-to-market is actually worth5,788,000 becomes 807,365 once the over-market stream, the expiry dates and the cost of re-letting are priced — and nothing at all below a 43.7 per cent renewal rate.
What a minimum payment actually does£81.53 leaves the account and £20.46 reaches the debt. On minimums alone the set clears in 258 months and repays 1.78 times what was borrowed.
What a month of delay costs in an enforcement463,000 euros of present value a month. No single error about enforcement, and no pair of errors, moves the indifference point from 58.7 cents to the 72 on the table.
What a pro rata cheque actually costsDefending costs 1.25 times the initial cheque across two rounds, not more in each — and below a 521 exit the follow-on dollars come back worth less than they cost.
What a subscription line does to the IRR20 per cent becomes 38.41 on the same asset while the multiple falls. Two dollars of interest buys 18.4 points, and the longer the line runs the cheaper each point gets.
What one point of fees actually costsOne point on the annual charge turns 738,846 into 567,961 over forty years — 23 per cent of the pot, and 2.43 of wealth lost per 1 of fee.
When the promote stops clearingCarried interest is not proportional to performance near the hurdle. It is a step function, and $2m of headroom is what stands between a promote and none.
Why a secondaries bid-ask gap has no zoneThe seller’s floor and the buyer’s ceiling are one formula at two rates. At equal required returns the zone is exactly zero — here it is 11.02 points apart.
Why refining a due diligence rubric makes it weakerThree of twelve managers carry a terminal flaw and the average approves all three. Splitting eight domains into sixteen makes it easier to hide, not harder.