Sunday, September 09, 2007

Complex hedges and the quant threat

O.K. So our IT CFOs are getting smart. They no longer settle for currency markets to determine their future. Joining the global trend of using exotic hedges to protect their realizations, they too are getting used to clever bets.

Check this out. Under the tailormade transaction known as STRIPS in market parlance, the corporate can settle the dollar every week, fortnight or month over the next few years, through what’s called a “series of options”. For years few bothered to use it, but in recent weeks there has been a flurry of activity. In the last one month, deals worth $100-200 million have been struck almost everyday.

Good. But coming to think of it, it’s a bet. The management strategizes, the operations team executes, marketing sells it and bills the client. All of them work so hard - only to stake it all in a quant bet? Here I risk sounding like your grandfather. But I am a sworn enemy of anyone trying to define a future thro quant theories and complex hedges. How many CFOs understand the complexity of hedge before they book one? After all, CFO is only an employee and not a shareholder who's ass is on the line if his call goes wrong. At best, he's a bean counter and can plead mea culpa... Since when has anyone been endowed with the power to call future course of a currency !

This seems to be the thrust of A.V.Rajwade’s article in BS. He says some instruments are so complex that it can take investment banks' computers entire weekends to value them! Can't agree more. The best hedge I go is constant investment in R&D led innovation to reduce costs, improve operational logistics and expand margins without affecting the cost to consumer. The day you think that's not possible and wait for exchange rate hedges to save your bottomline, it's time you exit the business and head for the hills. Because, you're on your way down...

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