A report on the hedging strategy of CITIC Pacific Limited

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IntroductionThis report is to check the hedging strategy that was used and lead to the huge loss of CITIC Pacific Limited and point out the importance of managing foreign exchange exposure through select appropriate hedging strategies. The huge loss of CITIC Pacific Limited and its cause is discussed in the first part. The importance of hedging and the tools of hedging are respectively reviewed in part two and part three. Finally, suggestions are given out on how to design proper hedging strategies for different enterprises. The huge loss of CITIC Pacific LimitedOn October 2008 21st, shares in CITIC Pacific (Listed in the HKEx) halved (http://news.bbc.co.uk/1/hi/business/7683160.stm) after the news of huge loss of foreign exchange was…show more content…
In theory, it has been proved that futures and swaps can be equal to the combination of forwards. (Hull J C, 1997)Generally, a foreign exchange settlement contract will be signed by banks and their customers, which stipulates the type of foreign currency to be used, the sum, the exchange rates and duration. On the due date when income or expenditure of foreign exchange occurs, currency exchange settlement will be operated in accordance with the contract. In order to improve efficiency, it's necessary to adjust the hedging when using forward contracts. (Brealey R, Kaplanis E. 1995)When the interest rate fluctuates randomly, the forwards strategy can be divided into three smaller parts: the Minimum Variance Hedging, Merton / Breeden Hedging and speculation. (Briys E, Solnik B. 1992)When the interest rate is certain, there is no price difference between futures contracts and forward contracts. Perfect hedge can be achieved, no matter what type of hedging tools is used. However, the two is no longer able to replace each other when interest rates move randomly, because of the existence of marking to market in futures market operation. The above selection is based on the effectiveness of futures and forwards. Next, the selection rules will emphasis on other features. Futures contracts are standardized by the Exchange, where the transactions usually take place. Forward contracts are signed between

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