Question

AAA Oil is an oil refining company. As an oil refiner, it purchases crude oil from drillers and refines the crude into multiple distillates on which it competes with a few other producers.

1. What are the market risks that AAA Oil has exposure to? Identify the direction of the exposures. Why does it have these exposures? How are the exposures translatable to the Income Statement?
2. Which of these exposures does it make sense for AAA to have a Tactical view? Why? Detail the circumstances that would drive AAA to initiate a tactical hedge.

Answer 1

1. AAA has both transaction and translation exposure .Since it is the purchaser of oil in foreign currency , any shootup in the prices of oil or any downside in its home currency will reduce it's margins. These exposure are to be recorded in books only after consideration of foreign exchange. It has these exposure as it deals with foreign currency in foreign markets.

2. Translation exposure will push it to go for tactical hedge as it highly affected by short term movement of foreign currency.

For example if the value of it's domestic currency goes down or value of foreign currency goes up, it can be said to be exposed to short term translation Risks and hence it can go for tactical hedging.