Through this adjustment of its asset portfolio, the ESGC creates a short position in the US dollar which exactly offsets the long dollar exposure created by the forward position.
Although the currency risk is perfectly hedged through these transactions, the ESGC bears some counterparty risk from the possibility that the exporting company is unable to deliver dollars at the maturity date of the forward contract.
By combining credit guarantees with its own operations, the ESGC will be able to provide trade financing as well as hedging services, as we will detail below.
We now provide a more detailed description of the workings of the ESGC through a series of examples.
Example 1: ESGC as counterparty to US dollar forward contract sold by exporter
Date 0 (initial date): The ESGC has equity of $100 million, and holds $100 million of US treasury bills.
First, the ESGC buys a forward contract from an exporter for the delivery of $1 million at date 2 (the maturity date) in exchange for KRW 1 billion.
Second, the ESGC sells $1 million worth of dollar-denominated assets and buys KRW 1 billion worth of short-term Korean government bonds.
Through this paired transaction, the ESGC ensures that its value remains at $100 million irrespective of subsequent exchange rate fluctuations.
The exchange rate will have changed from the contract date, but the ESGC can ensure its value remains unchanged after settlement.
The ESGC sells the KRW 1 billion worth of Korean government bonds on its portfolio, and delivers the won to the exporter, as specified in the forward contract.
The ESGC then purchases $1 million worth of US dollar safe assets, to bring its on-balance sheet portfolio to $100 million worth of US dollar-denominated safe assets.