This case presents a situation where the company Carter + Smith (C+S), which receives U.S. dollars to finance a Colombian pesos project, decided to create a hedge to cover the risk of an ex- change rate fall (revaluation of the COP against the USD). However, shortly after, there was a sharp rise in the exchange rate (devaluation of the peso), and this generated significant losses in the Non Delivery Forwards (NDF) contracts.

1. Carter + Smith Exchange rate risk hedges
This case presents a situation where the company Carter + Smith (C+S), which receives
U.S. dollars to finance a Colombian pesos project, decided to create a hedge to cover
the risk of an ex- change rate fall (revaluation of the COP against the USD). However,
shortly after, there was a sharp rise in the exchange rate (devaluation of the peso), and
this generated significant losses in the Non Delivery Forwards (NDF) contracts.

2. Brief background
• This case presents a situation where the company Carter + Smith (C+S), which receives U.S.
dollars to finance a Colombian pesos project, decided to create a hedge to cover the risk of an ex-
change rate fall (revaluation of the COP against the USD). However, shortly after, there was a sharp
rise in the exchange rate (devaluation of the peso), and this generated significant losses in the Non
Delivery Forwards (NDF) contracts.

3. Why did Hector shorted the NDFs?
• Hector engaged into the NDF transaction to hedge the currency risk (volatility) by going short on
USD and converting them to COP. The scenario was that hector anticipated to cover the revaluation of
pesos i.e the rate was set at 1898.41, if the exchange rate was below the NDF rate the position would
be covered but quite opposite would happen if the rate rallies above NDF.
• And that is what happened the rate rallied beyond the NDF and C+S had to bear losses (2400
pesos per dollar>1898 pesos per dollar).
• Although more pesos are earned for each dollar sold, losses on NDF contracts offset the gain on
exchange rate.

4. Why did Columbian peso devalued?
• When the exchange fell in 2014 as was believed by him primarily because of strong economic
indicators in Colombian economy, the NDFs offset the lower level of pesos they received for each
dollar sold.
• The trend of strengthening the peso against the dollar has been sharply reversed due to sudden
and sharp drop in oil prices.

5. Challenges being faced by Hector
 The first issue faced by Hector was to present the explanation on the losses to the board and as per the
case the board was mainly concerned with the net income, limiting hector to use financial and economic
technicalities as per this loss happened due to non-operating reasons i.e. Exchange rate fluctuation
 His other main challenge was to explain the mechanics of the hedging scheme implemented by C+S to
cover exchange rate risk. As he would have to clearly set out to the directors the costs and benefits of
closing the hedge immediately or letting the contracts mature.
 Hector faced another challenge of varied revenue projections due to the nature of this project

6. Alternatives
• Hector was remained with just two choices;
 To leave the hedge as it was (waiting till maturity).
 Settle the position with the current dollar at 2400 pesos. Realizing the losses on the NDFs

7. What should he do?
• Hector should consider on settling the positions @2400 COP at USD and realizing the losses. The reasons for
this are as under.
 C+S is completely exposed to the foreign exchange market losses and waiting would be equivalent to
posing more risk of losses as the situation is not favoring the Pesos to regain its value.
 Consensus even predicted the exchange rate to further devalue and go to 3000 pesos per dollar
 Even if the peso starts regain its value the problem would not be completely over as they would also have
to face the volume risk because the trade of such nature could not be expedited and thus decisions had to
be taken immediately.
 All he can do if he wants to not settle the contracts completely is to settle the contracts 1-14 and leaving
contracts 15-21 to reach maturity in hope that the peso would regain its value and nearing 1700 pesos (as
argued by some directors).

8. THANKS for paying attention