Hedging FX Exposure in Mexican Corn Imports

The United States is the world’s largest producer and the world’s largest exporter of corn.  It stands to reason that the CBOT Corn futures contract is the global benchmark for the market.  The US exports corn to destinations around the world, but Mexico is the largest export destination.  Similarly, the US is the main source of corn imports to Mexico, comprising around 90% of the inbound flow.  This trade relationship is therefore significant.

The CBOT Corn futures contract is an important tool to hedge these trade flows, but the costs to importers are exposed to foreign exchange (FX) risk, which may need to be managed.

Mexican imports of corn in 2018/19 are estimated to be 16.6 million metric tons, which is in addition to domestic production of approximately 27.7 million metric tons.  Imports of corn account for around one-third of Mexican supply, when stocks are taken into account.  Imports from the US are estimated at 15.7 million metric tons, equivalent to more than 600 million bushels.  The changing value of the Mexican peso (currency code MXN) against the US dollar can therefore have a substantial effect on the market.  With imported corn predominantly used for animal feed, FX market fluctuations can also have downstream effects.

To see an example of this, we can look at corn prices, both in US dollars and Mexican pesos over twelve months (from April 2019 through April 2020).

Source: USDA

Source: CME Group.  Active month CBOT Corn futures settlement price; converted to MXN using CME MXN/USD futures settlement price.

Before the spread of Covid-19 began to impact world markets, the relationship between the Mexican peso and the US dollar had been reasonably stable, typically in a range between MXN 19 and MXN 20 per dollar.  In March 2020, the dollar strengthened and in April 2020, the average exchange rate was around MXN 24.50, an appreciation of approximately 25% from the previous level.

As can be seen from the chart, this development in the FX market has had an impact on Mexican corn importers.  Whilst corn prices in the US have been falling towards the end of the period, in terms of Mexican pesos, the price for imports has risen.

This highlights the uncertainty that FX market prices can have for importers. Favorable movements in FX rates may well be followed by less favorable ones and vice versa.  For importers of corn into Mexico, a further strengthening of the dollar could extend the adverse impact already seen.

CME Group offers futures and options contracts on the Mexican peso, which can be used to manage this FX exposure.  These contracts are physically delivered at maturity, meaning that if held all the way to maturity, US dollars are exchanged for Mexican pesos to fulfil the contractual obligation.  Each futures contract is in the amount of MXN 500,000.  Using prices in April 2020, this equates to a contact value of around US$20,400, which can be compared to the dollar value of a CBOT Corn futures contract at the same time of around US$16,100.

Below are examples to show how the CME Mexican Peso futures and options contracts can be used to hedge the FX component of Mexican corn import transaction.

Scenario

In early May, a Mexican corn importer has an order to buy 1,500 metric tons of US corn to be delivered in one month’s time.  The agreed terms are for payment in US dollars at a rate equal to the CBOT Corn July futures price on the delivery day, plus 5 cents per bushel.

Transaction Information

Corn import quantity

1,500 metric tons (~ 59,052 bushels)

Agreed purchase price

CBOT Corn July Futures price plus 5 cents per bushel

Current CBOT Corn July futures price

310 cents per bushel

CBOT Corn futures contract size

5,000 bushels

Current CME Mexican Peso June futures price

US$0.04100 per Mexican peso

CME Mexican Peso futures contract size

MXN 500,000

Current Spot Mexican Peso price

MXN 24.2250 per US dollar

For the importer, this creates a one-month period of uncertainty regarding the cost that will actually be paid for the corn. This has two components: the price of corn and USD/MXN foreign exchange rate. Both these components of the risk can be hedged with futures

Hedging with FX futures

The exposure to the CBOT Corn price can be hedged with CBOT Corn futures.  With each futures contract representing 5,000 bushels of corn, buying 12 futures for the July delivery will effectively hedge this position with respect to the price of corn.   This futures position can be closed out on the day the trading company takes delivery of the order.

The current price of the CBOT Corn futures July contract is 310 cents per bushel.  Buying futures at this price will hedge the exposure to corn price fluctuations.  With a price of 310 cents per bushel established through the use of the Corn futures hedge, the trading company can be confident the cost of the imports will be 315 cents per bushel, i.e. including the agreed price premium.

The FX component of the transaction can be hedged using the CME Group Mexican Peso futures contract.  To determine the hedge transaction required, the trading company needs to determine whether to buy or sell futures, and the quantity to be transacted.

The CME Group Mexican Peso futures contract has a contract size of MXN 500,000, and prices are quoted in terms of the number of US dollars per peso.  Buying a CME Group Mexican Peso futures contract is equivalent to buying Mexican pesos in exchange for US dollars.  Selling the contract is equivalent to selling Mexican pesos in exchange for US dollars.

To purchase the corn, the Mexican trading company will wish to convert pesos into US dollars in order to make the payment, and therefore will be buying US dollars and selling Mexican pesos.  This requirement can be hedged by selling CME Mexican Peso futures contracts.  These futures should be sold to implement the hedge and subsequently purchased to close out the position once the FX hedge is no longer required.  The expiration of the CME Mexican Peso futures contract occurs in the middle of the named expiry month.  For example, the June futures contract expires in mid-June.  This would make it the appropriate futures contract month hedge for this transaction, which has an intended completion date in early June.

The number of FX futures needed to hedge the transaction can be calculated by considering the currency exposure.  With the corn futures hedge, the trading company will expect to pay US $186,015 to purchase the corn.

The futures price, quoted in US dollars per Mexican peso, is US$0.04100, which is the equivalent of MXN 24.3902 per US dollar.  At this exchange rate, the purchase cost will be MXN 4,536,951.  The contract size of the CME Mexican Peso futures contract is MXN 500,000, therefore to hedge the FX exposure, the trading company needs to sell 9 futures.

We can examine what might happen to this hedged position in different outcomes.  To focus on the FX component, let’s assume that the corn price is unchanged over the one-month period.

Outcome 1: An increase in the value of the Mexican peso

An increase in the value of the Mexican peso can also viewed as a decrease in the value of the US dollar, measured in Mexican pesos.  In this example, we assume an increase in value from US$0.041 to US$0.043 per Mexican peso.  This can also be seen as a change in value from MXN 24.3902 per US dollar to MXN 23.2558 per US dollar.

With the corn price stable at 310 cents per bushel, the purchase cost in US dollars is US$186,015, and the return from the corn futures hedge is US$0.  In local currency terms, the purchase cost is MXN 4,325,930, which is lower than anticipated had the exchange rate not changed.  This lower cost to the importer is offset by a loss made on the FX futures position.  Overall, the cashflow has been maintained in line with expectations, which is the purpose of the futures hedging strategy.

 

Physical corn

Physical MXN cashflows

Mexican Peso futures

Early May

 

Expected MXN 4,536,951

Sell 9 @ 0.04100

Early June

Buy 1,500mt @ 315 ¢/bushel

Actual MXN 4,325,930

Buy 9 @ 0.04300

Impact

 

+ MXN 211,021

-US$9,000

(- MXN 209,302)

Outcome 2:  A decrease in the value of the Mexican peso

A decrease in the value of the Mexican peso can also viewed as an increase in the value of the US dollar, measured in Mexican pesos.  In this example, we assume a decrease in value from US$0.041 to US$0.039 per Mexican peso.  This can also be seen as a change in value from MXN 24.3902 per US dollar to MXN 25.6410 per US dollar.

Again, with the corn price stable at 310 cents per bushel, the purchase cost in US dollars is US$186,015, and again the return from the corn futures hedge is US$0.  However, in local currency terms, the purchase cost is MXN 4,769,615, which is higher than anticipated had the exchange rate not changed.  To compensate, the FX futures hedge position records a gain of US$9,000, which equates to a gain of MXN 230,769.

 

Physical corn

Physical MXN cashflows

Mexican Peso futures

Early May

 

Expected MXN 4,536,951

Sell 9 @ 0.04100

Early June

Buy 1,500mt @ 315 ¢/bushel

Actual MXN 4,769,615

Buy 9 @ 0.03900

Impact

 

- MXN 232,664

+ US$9,000

(+ MXN 230,769)

Source: CME Group

Hedging with options on FX futures

We can also review the use of options to hedge the FX exposure.  Buying options can enable the user to hedge against an adverse move in the market, but continue to benefit from a favorable move.  This preferential exposure comes at a cost, which is the premium that is paid to buy the option.

An option on an FX futures contract gives the buyer the right to buy (when it is a call option) or the right to sell (when it is a put option) an FX futures contract at predetermined price.  This predetermined price is known as the strike price.  Multiple options positions can be combined to create tailored option strategy positions, which can provide a high degree of flexibility to the user, but for the purposes of this analysis, we will look at a straightforward example.

Let’s assume that the exposure to the corn price is managed in the same way, i.e. by buying 12 corn futures contracts.  The FX component can be hedged using options on the CME Mexican Peso futures contract.

The CME Mexican Peso futures contract has a contract size of MXN 500,000, and prices are quoted in terms of the number of US dollars per peso.   A call option is an option to buy futures, and therefore buying a call option is equivalent to having the right to buy Mexican pesos in exchange for US dollars at a fixed FX rate.  Other things being equal, a call option will increase in value when the value of the Mexican peso increases.

A put option is an option to sell futures, and therefore buying a put option is equivalent to having the right to sell Mexican pesos in exchange for US dollars at a fixed FX rate.  Other things being equal, a put option will increase in value when the value of the Mexican peso decreases.

The Mexican trading company will wish to convert pesos into US dollars in order to make the payment for the corn, and therefore, will be buying US dollars and selling Mexican pesos.  As can be seen in the futures hedging example, an increase in the value of the Mexican peso would reduce the purchase cost of the corn, measured in pesos, whilst a decrease in the value of the Mexican peso would increase the cost of the corn, measured in pesos.

The purchase of a put option would allow the trading company to offset the negative impact of a decrease in the value of the Mexican peso, whilst being able to benefit from an increase in the value of the peso.

For this example, the trading company buys put options which have a strike price equal to the current futures price of US$0.04100 per Mexican peso, equivalent to MXN 24.3902 per US dollar.    The number of options required to hedge the position is determined in a similar way to futures.  Each option is an option on one CME Mexican Peso futures contract which has a contract size of MXN 500,000.  The futures price, quoted in US dollars per Mexican peso, is US$0.04100.  At this exchange rate the purchase cost of US$ 186,015 will be MXN 4,536,951.  To hedge against adverse movements in the FX exposure, the trading company needs to buy 9 put options.

The put option has a premium, which is paid by the buyer at the time of the purchase.  Prices for the option are quoted in terms of the number of US dollars per peso.  The price for the US$0.04100 put option on the June futures contract is US$0.00102.   The total premium cost for the option is therefore US $4590.

This equates to MXN 111,193 at the prevailing spot FX rate.

It should be noted that the option on the June Mexican peso futures contract expires a few days before the underlying futures contract.  For this example, with delivery of corn in early June, hedging with options on the June contract will be satisfactory.

We can again examine what might happen to this hedged position in different outcomes.  To focus on the FX component, let’s again assume that the corn price is unchanged over the one-month period, and review the same movements in the FX rate as with the futures example, but also review the implication of no change in the FX futures price.

Outcome 1: No change in the value of the Mexican peso

In this example, we assume the Mexican Peso futures price remains unchanged at US$0.041 per Mexican peso (MXN 24.3902 per US dollar). With the corn price stable at 310 cents per bushel, the purchase cost in US dollars is $186,015, and the return from the corn futures hedge is US$0.  In local currency terms, the purchase cost is still MXN 4,536,951.  However, being very close to expiry, the put option giving the right to sell futures at US$0.04100 has a low value of US$0.00018.  Whilst there is no change to the purchase value for the corn, the loss in the value of the option should be taken into account.

 

Physical corn

Physical MXN cashflows

Mexican Peso options

Early May

 

Expected MXN 4,536,951

Buy 9 @ 0.00102

Early June

Buy 1,500mt @ 315 ¢/bushel

Actual MXN 4,536,951

Sell 9 @ 0.00018

Impact

 

+ MXN 0

-US$3,780

(- MXN 91,437)

Outcome 2: An increase in the value of the Mexican peso

In this example, we assume an increase in value from US$0.041 to US$0.043 per Mexican peso (i.e. a decrease in the value of the US dollar from MXN 24.3902 to MXN 23.2558).  With the corn price stable at 310 cents per bushel, the purchase cost in US dollars is $186,015, and the return from the corn futures hedge is US$0.  In local currency terms, the purchase cost is MXN 4,325,930, which is lower than anticipated had the exchange rate not changed.  Being very close to expiry, the put option giving the right to sell futures at US$0.04100 is valued at US$0.  The improved purchase value for the corn is therefore partially offset by a loss of premium value of the option.

 

Physical corn

Physical MXN cashflows

Mexican Peso options

Early May

 

Expected MXN 4,536,951

Buy 9 @ 0.00102

Early June

Buy 1,500mt @ 315 ¢/bushel

Actual MXN 4,325,930

Sell 9 @ 0.00000

Impact

 

+ MXN 211,021

-US$4,590

(- MXN 111,193)

With a greater increase in the value of the Mexican peso, the cost of the corn would decrease further, but this would not be offset by any further loss on the value of the put option.

Outcome 3: A decrease in the value of the Mexican peso

In this example, we assume a decrease in value from US$0.041 to US$0.039 per Mexican peso (i.e. an increase in the value of the US dollar from MXN 24.3902 to MXN 25.6410).  With the corn price stable at 310 cents per bushel, the purchase cost in US dollars is US$186,015, and the return from the corn futures hedge is US$0.  In local currency terms, the purchase cost is MXN 4,769,615, which is higher than anticipated had the exchange rate not changed.  In this outcome, the put option giving the right to sell futures at US$0.04100 has a value of US$0.00200 per peso.  The put option has increased in value, which partially offsets the increased cost of the corn.

 

Physical corn

Physical MXN cashflows

Mexican Peso options

Early May

 

Expected MXN 4,536,951

Buy 9 @ 0.00102

Early June

Buy 1,500mt @ 315 ¢/bushel

Actual MXN 4,769,615

Sell 9 @ 0.00200

Impact

 

- MXN 232,664

+ US$4,410

(+ MXN 119,576)

With a greater decrease in the value of the Mexican peso, whilst the cost of the corn would increase further, this would be fully offset by a higher value for the put option.

Please look at the graph below for a clear illustration of the impact of an FX options hedge:  

Source: CME Group

Conclusion

In uncertain times, hedging expected future revenues and expenditures can help to stabilize cash flow and create greater confidence in business performance.

For participants in international agricultural trade, CME Group’s suite of foreign exchange futures and options contracts complement the benchmark agricultural futures contracts and can provide for greater certainty and stability of cashflows and incomes.

Salient features of the futures contracts discussed in this article.

Contract

Corn futures

Mexican Peso futures

Options on
Mexican Peso futures

Exchange Listing

CBOT

CME

CME

Commodity Code

CME Globex: ZC
Clearing: C

CME Globex: 6M
Clearing: MP

Monthly:
CME Globex: 6M
Clearing: MP
Weekly:

CME Globex and Clearing: 1M, 2M, 3M, 4M, 5M

Contract Size

5,000 bushels

MXN 500,000

1 futures contract
(MXN 500,000)

Quotation

US cents per bushel

US dollars per Mexican peso

US dollars per Mexican peso

Tick Size

0.25 cents per bushel
US$12.50 per lot

US$0.00001 per MXN
US$5.00 per lot

US$0.00001 per MXN
US$5.00 per lot

Listed Months

9 monthly contracts of Mar, May, Sep and 8 monthly contracts of Jul and Dec

13 consecutive calendar months plus 2 deferred March quarterly cycle contract months

12 consecutive calendar months

Last Trading Day

Business day prior to the 15th day of the contract month

Second business day immediately preceding the third Wednesday of the contract month

Monthly:

Second Friday immediately preceding the third Wednesday of the contract month

Weekly:

Friday of the contract week

Settlement Method

Deliverable

Deliverable

Deliverable

Exercise Style

 

 

European style

Final Settlement Price

Delivery at the contract settlement price on the day on which the seller provides a notice of intention to deliver.

Delivery at the contract settlement price on the last trading day.

 

Author

Richard Stevens, Executive Director of FX Research and Product Development

For more information or to discuss any of the themes detailed here, please contact your CME account representative or fxteam@cmegroup.com

About CME Group

As the world's leading and most diverse derivatives marketplace, CME Group is where the world comes to manage risk. Comprised of four exchanges - CME, CBOT, NYMEX and COMEX - we offer the widest range of global benchmark products across all major asset classes, helping businesses everywhere mitigate the myriad of risks they face in today's uncertain global economy.

Follow us for global economic and financial news.

CME Group on Twitter

CME Group on Facebook

CME Group on LinkedIn

Emerging Market FX

Our transparent EMFX markets offer quick access to the reliable pricing and liquidity you need, on-screen and around the clock so you can act as markets move.

Start Trading