Furniture Hedging

Although many people may not consider sports gambling as a hedge, a Houston furniture store owner successfully did just that. Jim McIngvale offered purchasers of more than $3,000 in furniture double their money back if the Houston Astros won the World Series. McIngvale has offered similar promotions on other sporting events in the past, but to date, none have worked out for customers. However, when the Astros won the World Series on Saturday, McIngvale was obligated to pay customers back. To hedge his risk, his first bet on the Astros was a $3 million bet in May at 10-to-1 odds. He added about $7 million more in bets over the summer at average odds of +750. Because the Astros won the World Series, he received $75 million from various sports books to offset the refunds payable to customers. 

Pandemic Insurance

One way a company can alleviate risk is through insurance. For example, many companies have business interruption insurance (BII), which is a rider that pays the business owner if an event such as a fire or natural disaster makes it impossible to continue operations. If this happens, BII will pay the owner for lost revenue, an opportunity cost. Even though many businesses carry this rider, pandemics are excluded. For the insurance company, a fire affects few businesses at a time, and the losses are geograhically widespread and somewhat predictable for a large number of insured companies. With a pandemic, business interruptions are concentrated and much more numerous, as we have recently seen. Paying the large number of claims in this situation would bankrupt many insurance companies.

Recently, three major insurers have proposed that the Federal government create a plan to allow businesses to purchase BII that covers pandemic shutdowns. The proposed program would be modeled after the Terrorism Risk Insurance Act, which was enacted after 9/11. A similar program for individuals, which covers flood damage, is available to homeowners. On a personal finance side, we should make sure that you are aware that your homeowners policy will not cover flood damage. A separate policy, offered by the National Flood Insurance Program, must be purchased to cover this type of damage.

Loonie Taking Flight?

Since 2012, when the Canadian loonie reached parity with the U.S. dollar, the currency has taken a nose dive, dropping to a low of C$1.46 in early 2016. One benefit for Canada is that the cheap loonie created a trade advantage, helping that country's exports and benefiting the economy. With a better economy, whether the loonie will once again take flight is an important consideration for U.S. companies doing business in Canada. Strengthening of the loonie will increase the cost of goods imported to the U.S. from Canada, thereby reducing profits. These companies can lock in costs with forward contracts for commodities, or by hedging currency risk with futures, options, or swaps.

Currency Trading Shrinks...Maybe

So how much currency do you think is traded daily? According to a recent report published by the Bank for International Settlements (BIS), average daily trading in April 2016 was about $5.1 trillion! This was down from $5.4 trillion per day in April 2013. However, if the dollar had not appreciated over the period, average daily volume would have risen about 4 percent. Spot currency trades were about $1.7 trillion per day, swaps accounted for about $2.4 trillion per day, and the rest of the trading was for other over-the-counter foreign currency derivatives. The U.S. dollar was on one side of 88 percent of trades, while the euro was on 31 percent of trades.

Negative Yield Triangular Arbitrage

A question we often get is if the material we discuss is actually relevant to the real world. However, we can see the application of triangular arbitrage with the seemingly strange desire of investors to purchase the $9 trillion in below zero interest sovereign debt. A Japanese 3-month government bill is currently returning about negative .24 percent. The buyer can borrow at the yen 3-month LIBOR, which is about negative .02 percent and receive the dollar LIBOR at .82 percent. The buyer then executes a yen-dollar swap, which results in a dollar-hedged yield on the trade of 1.24 percent. With the 3-month U.S. Treasury yield about .25 percent, and increase in annualized return of about one percent is a huge increase for portfolio managers.

Delta Loses Big On Fuel Hedge

Companies with significant risks, such as currency or commodity risks, often hedge exposure to that risk. An industry with a a history of hedging is the airline industry, with companies often hedging fuel prices. However, not all hedges make money. For example, Delta Airlines recently announced that it lost $450 million on its fuel hedges in the second quarter of 2016 as it closed all of its hedges for the year. Delta is not alone as other airlines such as U.S. Airways and United have abandoned fuel hedges, citing lower fuel prices. We would like to point at that lower prices are not a good reason to eliminate hedges. By eliminating its hedges, Delta is now subject to the risk of increasing fuel costs. A hedge is designed to reduce volatility, so a reason to not hedge is the lack of volatility, not low prices, a fact often missed. Looking at the quote in the article from CNN Money: “Fuel prices are up 60% from their January lows, but they’re down 20% from a year ago. So, even with the cost of canceling its fuel contract, Delta will save money on fuel … in the second quarter.” While we agree that Delta will make more money with lower fuel prices compared to January, if fuel prices increase, Delta will not make as much as they could have going forward.

Golf And Investing

A recent article discusses how golf and investing may be related, but also talks about several behavioral biases that can affect investors. For example, loss aversion shows up in golf as golfers are more likely to make a putt of the same difficulty for par than they are to make the putt for birdie (one under par). Another behavioral bias discussed is probability neglect, that is, people tend to worry about bad outcomes that have a very low probability, such as a plane crash or losing 40 percent of their investment. By overweighting events with a low probability, investors can incur large opportunity costs. Finally, an informational cascade occurs when investors believe the signals from other investors, even if they do not agree. For example, if a stock you view positively begins to drop, you may sell based off what other investors are doing, rather than what your research has revealed to you. As the article notes, smart investors aren't loss averse, they don't neglect probability, and believe in their own analysis. 

Citigroup's Swiss Franc Loss

In 2011, the Swiss National Bank pegged the Swiss franc to the euro, at a rate of 1.2 francs per euro. As recently as December, Swiss officials stood by the peg. Then, on January 15th, the Swiss National Bank unexpectedly removed the peg, sending the Swiss franc up up by 30 percent on the day. Unfortunately for Citigroup, the company had let it's Swiss franc hedge expire the previous week. As a result, Citigroup lost more than $200 million in the hours following the announcement. Of course, not everyone lost: It was reported that JPMorgan Chase & Co. had gained $300 million on the removal of the franc peg. The cost of the hedge was likely a reason that Citigroup allowed the position to expire. During the previous year, Citigroup lost $100 million on a hedge tied to unrest in the Ukraine.