Overdraft and Overhedging: Difference between pages

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imported>Doug Williamson
(Add overdraft example.)
 
imported>P.F.cowdell@shu.ac.uk
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1. ''Facility''.
Overhedging is a form of speculation.


An overdraft facility is a line of credit which is applied to a current account and may be drawn on demand.
It means intentionally hedging an amount GREATER THAN the total related risk exposure, for example by the use of a derivative instrument with a principal amount of 200% of the related risk exposure.  


It is also known as a demand loan, as it is repayable to the bank on demand by the bank.
The effect of overhedging in this way is to create a new purely speculative position in the derivative instrument.


For this reason, it is risky to use overdrafts for core financing needs.
The size of the new speculative position is equal to the excess of the principal amount hedged, over 100%.




2. ''Liabilities.''
For example in this case the size of the new speculative position is 200% - 100% = 100%.  


The amount by which an account is overdrawn.
In other words equal in size to the original exposure being hedged.
 
Also known as an overdraft balance.
 
 
:<span style="color:#4B0082">'''''Example: Overdraft'''''</span>
 
:We have an overdraft of £50k at the start of April. In other words we owe £50k to the bank.
 
:We need to put more money into our account.
 
:Now we deposit £60k into the account during the month of April.
 
:This repays our overdraft, with some cash left over.
 
:At the end of April, our bank account now has a positive amount in it, of:
 
::-50 + 60 = 10k
 
:We now have £10k cash in our bank account at the end of April.
 
:The situation of a positive amount in the bank is known as cash at bank (or being 'in credit').


The new speculative position is in the opposite direction to the original exposure.




== See also ==
== See also ==
* [[Balance]]
* [[Hedging]]
* [[Bridge financing]]
* [[Underhedging]]
* [[Concentrate]]
* [[Facility]]
* [[Liabilities]]
* [[Overdrawn]]
* [[Revolving credit facility]]
* [[Round tripping]]


[[Category:Liquidity_management]]
[[Category:Risk_Management]]
[[Category:Commodity_Risk]]
[[Category:FX_Risk]]
[[Category:Interest_Rate_Risk]]

Revision as of 14:25, 12 August 2014

Overhedging is a form of speculation.

It means intentionally hedging an amount GREATER THAN the total related risk exposure, for example by the use of a derivative instrument with a principal amount of 200% of the related risk exposure.

The effect of overhedging in this way is to create a new purely speculative position in the derivative instrument.

The size of the new speculative position is equal to the excess of the principal amount hedged, over 100%.


For example in this case the size of the new speculative position is 200% - 100% = 100%.

In other words equal in size to the original exposure being hedged.

The new speculative position is in the opposite direction to the original exposure.


See also