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[null,"OPTIMAL HEDGING STRATEGY"]
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[null,"INPUT",{"$nulls":5},"EXPLANATION"]
[null,"Enter parameters into blue cells"]
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[null,"Determine Risk Aversion - Sigma",{"$nulls":5},"The risk aversion Sigma  represents the level of risk the firm is willing to undertake."]
[null,"Probability firm will experience fiscal distress in a decade = ",null,null,{"v":1,"d":"1.00"},"%",null,"The maximum allowable probability of the firm not able to meet financial obligations in 10 years."]
[null,"which translates into the probability of distress in any 1 year of ",null,null,{"v":0.10045287082499632,"d":"0.10"},"%",null,"Translating that quantification to the maximum probablity of financial distress in 1 year."]
[null,"which translates into a risk aversion Sigma of ",null,null,{"v":3.0889103030458793,"d":"3.09"},null,null,"Translating into a risk aversion parameter. It is a nonlinear function with >3 tending \"conservative\"."]
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[null,"Model Parameters",{"$nulls":5},"The main input box to enter parameters for the optimal hedging calculation."]
[null,"Total firm earnings ($)",{"v":58.6,"d":"58.60"},"Earnings exposed ($)",{"v":11.5,"d":"11.50"},null,null,"Higher proportion of earnings exposed, less internally diversified, and a more likely hedging gain."]
[null,"Volatility of hedgable risk price (SD as % of mean)",null,null,{"v":15,"d":"15.0"},null,null,"More volatile the hedgable risk price, the more useful hedging is. In contrast, the more volatile the non-hedgable earnings, hedging is less useful as more earnings volatility comes from other factors."]
[null,"Volatility of non-hedgable earnings (SD as % of mean)",null,null,17.4]
[null,"Marginal Cost of hedging (cents per $1 hedged)",null,null,{"v":0.4,"d":"0.40"},null,null,"The lower the expected cost of hedging, the more the firm should hedge."]
[null,"Risk free rate (%)",{"v":5,"d":"5.0"},"CoC hurdle rate (%)",{"v":11,"d":"11.0"},null,null,"The higher the cost of capital, the more the firm saves by freeing up capital reserves."]
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[null,"Result:",{"$nulls":5},"The result gives the optimal proportion of exposure to hedge given all of the parameters."]
[null,"K = ",{"v":0.022877539239965775,"d":"2.29%"}]
[null,"Optimal hedge = ",{"v":0.2668211416497229,"d":"26.7%"},"of earnings exposed,",{"$nulls":3},"The proportion represents the equilibrium condition where the marginal cost equals marginal benefit."]
[null,"or ",{"v":3.0684431289718135,"d":"$3.07"},{"$nulls":4},"The optimal dollar amount to hedge equals the optimal proportion times the earnings exposed.",null," "]
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[null,"EVA or Net Savings",{"$nulls":5},"Net savings represent a prehedge capital reserve released (or redeployed)."]
[null,"SD Earnings prehedge",{"v":8.374974994589534,"d":"$8.37"},"SD Earnings at hedge",{"v":8.292414127596444,"d":"$8.29"},null,null,"The standard deviation (volatility) of firm earnings before and at the optimal hedge."]
[null,"Capital released",{"v":0.24274934016746805,"d":"$0.24"},{"$nulls":4},"The freed-up capital is determined by the reduced volatility and size of reserves held per volatility unit."]
[null,"Gross savings",{"v":0.014564960410048082,"d":"$0.01"},"Cost of hedging",{"v":0.012273772515887254,"d":"$0.01"},null,null,"Gross savings represent the difference between investing the capital in the firm and keeping reserve."]
[null,"EVA or Savings",{"v":0.002291187894160829,"d":"$0.002"},"--> % of exposure",{"v":0.0001992337299270286,"d":"0.02%"},null,null,"After deducting the hedging cost, the net savings can be set against the exposure for benchmarking."]