A Hedge! A Hedge! My Kingdom for a Hedge!
Four centuries ago, the most influential English-language playwright in history was laid to rest in Stratford-upon-Avon. Yet since April 25th, 1616, William Shakespeare has captivated four centuries of audiences and readers with his masterful dramatic arcs, playful neologism, and comprehensive depiction of life’s full breadth. In fact, Shakespeare’s astonishing thematic scope led Ralph Waldo Emerson to declare: “What point of morals, of manners, of economy, of philosophy, of religion, of taste, of the conduct of life, has he not settled? What mystery has he not signified his knowledge of?”
As we reflected on Emerson’s adulation, it dawned on us that if Shakespeare really did settle all points of the economy, he must have written plenty about risk management. We spent the weekend curled up with our college Shakespeare text and, as we pored over the plays for the first time in years, we marveled at just how often he signified his knowledge of hedging’s mysteries.
Rather than expect you to blaze through 884,647 words and find those insights, dear reader, we’ve reproduced the most important ones below. After all, brevity is the soul of wit, right? A couple of them may sound different from the way you originally read them, but if the bard could invent “zany,” “rant,” “swagger,” and more than 1,000 other new words, perhaps we can take some creative license as well.
(1) So foul and fair a day I have not seen. When Macbeth reflected on his military victory, the day looked fair; when he remembered the lives lost and saw the stormy weather, the day seemed foul. Every hedging analysis includes this kind of balanced perspective: if the underlying asset appreciates, the hedge will depreciate, if the underlying depreciates, the hedge will appreciate. But perhaps it doesn’t have to feel foul, since the outcome is already known in advance.
(2) The fault is not in our stars but in ourselves. Cassius urged Brutus not to assume that the stars controlled their destinies, but that they could become masters of their own fates. In the same way, as we read numerous quarterly earnings statements detailing profitable quarters in foreign currency terms wiped out by U.S. dollar strength, we can’t help but remember the words of Cassius. The fault lies not with foreign currency variability; after all, the ability to repatriate revenues to dollars via appropriate risk management tools lies with ourselves.
(3) What’s in a name? That which we call a rose, by any other name would smell as sweet. While Juliet stood on her balcony and first regretted the fact that Romeo was called a Montague, she concluded that his character was far more important than his name. Though perhaps she didn’t realize it, she was actually offering sage advice to any company that gets pitched a rosy-sounding “curve-efficient,” “protective,” or “proprietary index yielding” instrument. The way to judge any financial instrument pitched is not by its name, but by its financial properties, including how it behaves in adverse and extreme scenarios – not every rosy pitch book really leads to a sound investment.
(4) Neither a speculator nor a non-hedger be. Like any father, Polonius wanted to steer Laertes away from extremes that could damage him financially. If Laertes had access to the modern financial markets, we don’t doubt Polonius would have urged him neither to use derivatives for speculative purposes, nor to ignore his risks completely by not calculating his exposures and hedging them appropriately. Without question, a speculative derivative oft loses both itself and friend, and ignored financial risks dull the edge of husbandry.
(5) To swap or not to swap; that is the question. Whether ’tis nobler in the deal to suffer the slings and arrows of interest rate fortune, or to fix rates against a sea of troubles. Hamlet’s soliloquy hits the big question borrowers have been asking for the last few years. Naturally, fixing rates with a longer-term swap can require immediately paying a higher rate than current floating interest. But locking in historically low rates means ending the heartache and the thousand natural shocks that unhedged rate risk is heir to. No wonder Hamlet called the peace of mind afforded by fixing borrowing rates a consummation devoutly to be wished!
Noble friends, please don’t find yourselves unprotected in an adverse rate environment, crying out like King Richard III: “A hedge! A hedge! My kingdom for a hedge!” Instead, as the Bard himself counseled four centuries ago, “love all, do harm to none, and trust a few [expert & independent advisors on how to manage your financial risks].”
If we authors have offended,
Think but this, and all is mended—
That you have but slumbered here
While these visions did appear.
And this weak and idle theme,
No more yielding but a dream.