Hedging on Venezuela


Hedging ShearsCNBC has an interesting article on the companies that are taking a hit thanks to Giordani et al. They provide some detail into the issue of why these companies didn’t hedge against the risk of devaluation, even when everyone knew it was coming. The money quote:

In Venezuela, “there is very little a company can do to hedge their exposure,” Willie Williams, director of institutional derivative sales at Societe Generale, told CNBC.com. “There is no non-deliverable forward market like in Brazil to hedge exposures. The best many companies can do is have expenses denominated in bolivars as well.”

Even if a company could find a way to hedge bolivar exposure, it could be very costly, says Eduardo Suarez, a currency strategist at Scotiabank. Trading volume in the “formal market” for the bolivar is usually less than $100 million per day, he says, and “such a small formal market would probably mean very high costs for the large transactions multinationals would require.”

There would be carrying costs for a hedge as well, he said. “Unless you time the hedge very well, you would be forced to pay a large negative carry to keep the hedges on for a prolonged period due to rate differentials.”

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  1. This article uses two of economic terms that I don’t know (including the main one):

    – Hedging exposure

    – Non-deliverable forward market

    Can some kind economist do me a second and explain what these things are?

    • I’m no financial wizard but presuming you know what a hedge/hedging is (investment position usually used to offset [potential] losses) then the exposure would be the level of risk. Any number of thinks could make the original hedge more risky or less risky e.g. currency fluctuation, equity risk (depreciation etc).

      Non-deliverable forward market is another financial term (note finance, not economist) that isn’t that complicated but it heard to put in a few words! Basically non-cash off balance sheet trade where at the end of the term only the difference between the set starting rate and final spot rate is paid; developed for emerging markets where there are controls or where the currency cannot be easily delivered elsewhere. See here:


    • Let’s use Japan, where there are no controls, as an example. Today the Yen is let’s say 93 yen per US$. You are a company that will make more or less 93 million yen (one million dollars) in the next three months, but you know that the yen is going down (it is). You cover the possibility of losing a large part of those earnings by “hedging your exposure”, i.e. buying yens at a fixed price in three months, say at 95 yen per US$. If in three months it is at 100, you saved a lot of money, if it is at 94, you lost some money but at least you locked in the price. You protected your gains.

      A non-deliverable forward is a product whereby you purchase yens at a certain date in the future, say the example above, at 95 yen per US$. But in three months, you don’t get the totals dollars, but the difference between the price (95) and the true price at the time. On the day it expires you either pay the difference or receive the difference between the agreed price 95 and the market price, if it is below or above the agreed price.

    • So the idea is that you set a price in the future for the yen, and if it’s higher you get payed the difference, but if it’s lower you pay it? And the initial price itself loses all value in the end?

      And if I got it right, that means that it can only make sense if there is reason to believe that a big devaluation is coming because you are expecting to see the money from the difference as at least more or less equal to the current price?

      • I think Sr. Octavio nails it.

        It all comes down to future expectations. As has been well-explained above, you generally seek to hedge when you have some belief that the value of your funds in the foreign currency is going to drop (depreciate) versus the relative value of your preferred/reserve/home currency. So, you risk a small amount of the funds (anywhere from 10-600 basis points) to mitigate a negative outcome. Key takeaway is that you aren’t trying to improve your position, but simply avoid a greater negative one.

        Now, that said, hedging is pretty common, particularly when you have a large amount of revenue being generated in the origin country for return to the corporate HQ or if you simply make most of your purchases/settlements for inventory in non-origin country funds (which is the case in Venezuela…who actually buys goods there when it is easier and more profitable to import them?) Bear in mind, that a hedge has a pretty minor downside and a pretty significant upside under “normal” circumstances.

        The problem with VZLA is that the circumstances are anything but normal. Remember that a hedge typically requires a diversity in expectations and a counterparty and in this case, particularly in the financial community, all expectations have long been a devaluation and everyone is a seller; no one a buyer. They note in the article that the market is so minimal that these businesses have little means of repatriating their profits and the cost of the hedge is well outside a real cost range that makes any sense. Its far easier to let the funds ride “naked” and writedown and incurred costs (typically as a means of reducing tax liability) than it is to continuously pay for hedges.

        The NDF scenario is an exact example of the problem. You have the spot rate of 4.3 (cum 6.3) but you have no idea what the future expectation/market rate will be, as we discussed previously, and as such cannot arrive at the differential valuation. Nothing kills a market like external uncertainty whereas internal uncertainty drives transactions.

        Again, this is part an parcel of why Venezeula has a broken economy. All outflows are private (or brokered by the government), all inflows are governmental and the mechanism to create a market between them is more or less broken. Highly dysfunctional and, when all is said and done, quite stupid. It won’t change until they revalue the bolivar at a nominally close market rate and begin removing controls.

        Interesting anecdote: a family member negotiating airfare for my wife’s visit was offered 30 for a dollar on the price of a ticket. Went “outside” to talk some more and settled at 35. How wild is the market for dollars getting when it is that far outside the band?

    • Perfectly explained in the article.

      The only thing to add is, what to do with the excess “bees” any given company accumulates, but cannot repatriate. Do as ordinary Venezuelans do, and spend it. Buy the building that houses your offices, buy land for a new warehouse (and build that new warehouse), buy the car fleet for your sales force (instead of renting), produce advertising material locally, buy three years worth of Venevision advertising time, if you can…

      Much of this would be an inefficient use of cash, under ordinary circumstances. But, the circumstances are far from ordinary, and the leftover cash will still be “ginormous” (just imagine that earnings losses declared by the companies you cite are ~15% of something — and I suspect that cash or its equivalent is a big piece of that something.)

  2. Though I barely understood the point, It’s a very difficult reading.

    Sorry for my ignorance, but it seems that these companies that are now reporting losses due to the devaluation of the currency, they didn’t secured their investments using hedge funds. But how can they do that? You still need to move your assets (now in Bolivares) to dollars in order to use this mechanism right?

      • Not hedge funds, but hedges. In this context, a hedge is simply a side bet, usually at a small cost, to protect the majority of your assets, which for these companies, was largely cash or cash equivalents in the bolivar that they wanted to trade at some point for dollars.

        Standard currency hedges are forward or future contracts, which are derived at through future expectations (someone bets the currency will decline or appreciate, so they will buy/sell obligations at a future date) and how this in turn leads to inflation and interest rate differentials as well as governmental policy. The NDFs require a bit more assumptive risk, but are still tied to expectations and typically happen where currency controls exist because they tend to operate outside of standard market means.

        A consumer example of a hedge is pretty straight forward in Venezuelan terms. Say you finish contract work in January of 2013 that you’ve spent a lot of time on in the past year and for which you are owed 200,000 bolivars. Sounds like a lot of cash and you expect it to last you the remainder of the year…except inflation is kind of crazy and you expect the economy to not function so well. Plus, you’ve been reading Caracas Chronicles which has had some alarmist articles on devaluation of the currency in the future and despite the rojo rojitos claiming otherwise in the comments, what they are saying makes a certain sorta sense.

        So you are worried about all that cash…and keeping it in your house seems a bit crazy since people know you finished the contract and…well,…large amounts cash are such inviting targets…also, things get more expensive every day. So you think of a couple of things you can do. 1) Spend it on assets that will still be worth a large amount of money in a few months and that you can utilize or sell whenever you like…like that sexy red 2012 Chery Arauco, a new refrigerator and a nice flat screen tv. 2) You can loan it back out in a private contract to a friend who wants to start a business and offers to pay you 3000000 bolivars in exactly 1 year. 3) Sell it for dollars with ease through the wonderful and helpful folk at CADIVI at the legal rate…after all, you wouldn’t want to sell it at the parallel rate and do something illegal, right? And when the time comes and you needed BF again, you’d certainly exchange those dollars back lawfully, right? 4) Spend several hours in line at the bank to deposit your funds just so you can earn that awesome interest rate on savings. 5) Use it to fund your local Pemon-run Venezuela to Colombia gas exchange. 6) Spend it all immediately on things like vacations and nice dinners.

        Which hedge would you choose? Why?

  3. TICC bonds issued by the National Treasury are a good hedge. They are nominated in dollars and indexed to the official exchange rate. The market value of the bond is calculated by the nominal*Price*exchange rate so that, if the exchange rate goes up, then ceteris paribus, the market value goes up as well.


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