Key question
When commodity costs are hedged in a foreign currency, how should hedge maturities be aligned to eliminate residual FX risk?
Commodity purchases in a foreign currency create a two-layer risk
When a company sources commodities priced in a currency different from its reporting currency, two independent risks arise: commodity price risk and FX transaction risk. Example: a EUR-reporting manufacturer buying coffee priced in USD faces both coffee price movements and EUR/USD exposure on the USD payments.
Illustrative — two independent risk sources moving separately
Misaligned hedge maturities introduce a hidden third risk
When the commodity and FX hedge horizons differ, a residual FX exposure appears. Its size is measured as tracking error — which falls to zero when both horizons align. Volatility and drawdown stay broadly stable regardless of horizon; only the maturity gap matters. Example: commodity fixed 3m ahead, FX hedged for 6m — the USD amount changes in months 3–6 without cover, creating extra cost volatility in the reporting currency.
Tracking error by commodity hedge horizon — drops to zero when matched with FX horizon
Commodity costs and hedge horizons
FX hedge horizons
Mismatch of 3m — residual FX exposure
Tracking error by commodity hedge horizon
Tracking error measures the residual cost volatility caused by the maturity mismatch. With FX hedge fixed at 6m, any other commodity horizon introduces extra volatility. Use the slider in "Your company" to see the effect.
Commodity horizon
3m
3m mismatch
Tracking error (EUR mn)
26
residual FX exposure
Volatility
33.5%
annual — stable across horizons
Selected horizon highlighted. At 6m — tracking error = 0.
Optimal hedging approach
Two routes to eliminate the mismatch: align the commodity and FX hedge horizons, or use a quanto product that fixes the commodity price directly in the reporting currency.
Route 1 · Align horizons
Match to 6m
procurement adjusts to treasury's horizon
Route 2 · Quanto hedge
Single product
fixes coffee price in EUR directly
Demo is based on historical data. In the full version — current data, your commodity, your company's portfolio.