I have a SEK based company with a large goodwill post in USD. A 15% depreciation of USD ag SEK would make my equity negative.I want to apply a long-term hedge against this translation risk. What would be the best way to do this: FX forwards or a basis swap? What would be the difference? How would I go about to minimize the liquidity effect when the hedge expires? Are there any new/exotic products or structures I could use? Given the (historically seen) cheap USD, could I apply an option based strategy or would the long horizon make this too expensive and/or would it casue any other problems for me?I'm nervous about this, I need to be able to apply hedge accounting. Any input would be much appreciated.Thanks.

As I understand, a basis swap involves swapping the money market rates in two different countries, it seems your concern is the pure spot exchange rate. While the two are clearly connected it seems sensible to focus on the pure spot (or forward) rate as this is what you are worried about. Long term FX forwards are likely to be very illiquid esp for USDSEK so probably not an option. More realistic is to pick a liquid forward tenor (eg 3 months) and roll the hedging program every 3months. this protects against sudden jumps and day-to-day fluctuations, but leaves you exposed to a long term slow slide as each roll you will be re-hedging at a worse rate. Liquidity all depends on the amount we are talking about for USDSEK you can probably do say up to $50mUS at a time no problems. For >> this amount you would need to manage it more carefully.Hedging using FX options mean that your hedge ratio changes as the underlying spot changes, ie you become more hedged the more USD depreciates, if you strike your option initially ATM then your hedge will increase from c50% toward 100% as USD depreciates. As before you'd need to pick a liquid tenor and roll the program accordingly. Simply transacting a long term option might mean v. high transaction costs and also less gamma, so your hedge ratio will change more slowly with the underlying.With option based hedge you are also essentially short-vol so can lose money on vol increasing.

It’s true that my only (or at least main) concern is spot risk. With long term hedge I actually mean around 5 years, but as I don’t know when I will exit my USD asset It might as well show to be 10 years (although I hope not). I’m not too worried about liquidity at this stage as I know from experience I can do pretty large amounts USDSEK fwds up to 5 years. Even I’d get a rip-off price given bad liquidity I already have more than 2000 SEK pips working in my favour, so it’s not a real issue I think.What worries me is the liquidity effect from an expired hedge. I would face this if I had one expiry date for the whole amount, or I could split the amount into let’s say 12-24 months, but still I’d have that effect. What I would like to do is to do start off with a fwd expiring Dec09 and then roll over this every year with a currency swap at historical rate. That way I would eliminate the spot risk and only be exposed to differences between USD and SEK deposit rates. However, law prohibits me from rolling over at historical rate.One of my ideas is to do some kind of extendible or callable currency swap, where every year I can choose to keep the hedge or exit. I would then pay for example USD Libor 12m every year on the initial USD amount and receive Stibor 12m +/- a spread. If I don’t cancel the swap, these payments would be capitalized using my credit lines with the bank, and not paid until I exit the hedge. This way I would avoid any liquidity effects during the life of the hedge.

yeah, sounds sensible. My general thought is, with a structure like that are you not just offloading the same liquidity risks to your banking counterpart (as presumably they will just hedge their exposure to the structure using forwards in the same illiquid markets) and therefore you pay extra for them to worry about the problem rather than you worry about it. But maybe thats ok for you as you have the headroom in your favour.With a 10 year structure would there also be potential MtM risk if the two yield curves did strange things in the meantime ?

Whether you do a one day, 1 year or 10-year forward rate depends on how you are funding your $ asset as doing the fx ehdge will shift your funding to SEK as well as giving you SEK rates of return on your $ asset. another thing you should consider is the fact that you may need to post variation margin on you hedge. this should be considered carefully.

quite right, Metalgesellschaft and all that...