Why This Matters
At the institutional level, currency risk management goes beyond the simple Kwanza/USD allocation split taught in Level 2. Pension funds, sovereign wealth funds, and multinational corporations operating in Angola use sophisticated hedging instruments and overlay strategies to manage currency exposure with precision. As Angola’s financial markets develop, these tools are becoming increasingly relevant.
Currency Forwards in Angola
A forward contract (contrato a termo) is an agreement to exchange currencies at a predetermined rate on a future date. The BNA and commercial banks offer forward contracts for USD/AOA.
How it works: You agree today to buy USD 100,000 at AOA 870 per dollar in 6 months. Regardless of where the spot rate is in 6 months, you pay AOA 87,000,000 and receive USD 100,000.
The forward rate is not a prediction of future rates. It is derived from the interest rate differential between the two currencies:
Forward Rate = Spot Rate × (1 + Kwanza Rate) / (1 + USD Rate)
With spot at 914, Kwanza 6-month rate at ~10% (annualized 17.5% / 2), USD 6-month rate at ~2.5%: Forward = 914 × (1.10) / (1.025) = 914 × 1.073 = ~981
The forward Kwanza is weaker than spot — this reflects the higher Kwanza interest rate. This is called a forward premium (in USD terms) or forward discount (in Kwanza terms).
Key insight: The forward rate builds in the interest rate differential. You cannot get “free” hedging — the cost of a forward hedge is approximately equal to the interest rate differential you sacrifice.
Hedging Strategies
1. Full Hedge
Hedge 100% of foreign currency exposure using forwards. An exporter expecting USD 1,000,000 in 6 months sells USD forward at the 6-month forward rate.
Advantage: Complete certainty on Kwanza proceeds. Disadvantage: If Kwanza depreciates more than the forward implies, you miss out on favorable spot rates.
2. Partial Hedge
Hedge 50-75% of exposure, leaving the remainder unhedged. This balances certainty with optionality.
Advantage: Protection against severe depreciation while retaining some upside if Kwanza strengthens. Disadvantage: More complex to manage, still exposed to currency risk on the unhedged portion.
3. Rolling Hedge
Use a series of short-dated forwards (e.g., 3-month) that roll upon expiration. This provides ongoing hedging without locking in a single long-dated rate.
Advantage: Adapts to changing market conditions as each forward is re-priced at current rates. Disadvantage: Roll risk — rates may be unfavorable when you need to roll.
Currency Overlay Strategy
Institutional investors use a currency overlay (sobreposição cambial) to separate currency management from asset allocation. The investment team selects the best bonds and stocks regardless of currency. A separate currency overlay then manages the aggregate portfolio’s currency exposure.
Example: A portfolio holds:
- Kz 20B in Kwanza bonds (Kwanza-exposed)
- Kz 8B in USD-indexed bonds (partially USD-exposed)
- Kz 12B in BODIVA equities (Kwanza-exposed)
Underlying currency exposure: 80% Kwanza, 20% USD
Target currency exposure: 60% Kwanza, 40% USD
Overlay action: Sell Kwanza / Buy USD forward on Kz 8B notional to shift 20% of exposure from Kwanza to USD. This is done through forward contracts without changing the underlying asset positions.
The overlay allows the portfolio to maintain its optimal asset allocation while independently managing currency risk.
Worked Example: Hedging an Import Business
Importadora Luanda SA imports $500,000 of goods monthly from China, paying in USD. Revenue is in Kwanza. The company needs to manage USD/AOA exposure.
Current approach: Buy USD spot each month. If the Kwanza depreciates unexpectedly, import costs spike.
Hedging program:
- Hedge 75% of next 6 months’ USD needs with rolling 3-month forwards
- Monthly forward purchases: $375,000 at 3-month forward rate
- Buy remaining 25% ($125,000) at spot to benefit from any Kwanza strengthening
Quarter 1 result:
- Forward rate: 875 (locked in)
- Spot rate at expiry: 890 (Kwanza weakened)
- Hedged portion: Saved Kz 5,625,000 vs. spot (375,000 × 15 Kz saving per USD)
- Unhedged portion: Cost Kz 4,250,000 more vs. forward rate (125,000 × 15 × 3 months, partially offset)
- Net saving: approximately Kz 12,500,000 over the quarter vs. fully unhedged
The hedging program did not eliminate currency risk but reduced its impact by 75%.
Key Takeaways
- Forward contracts are the primary FX hedging tool — they lock in future exchange rates based on interest rate differentials
- The cost of hedging equals the interest rate differential — there is no free hedge
- Partial hedging (50-75%) balances certainty with optionality
- Currency overlay separates FX management from asset allocation — an institutional best practice
- Rolling short-dated forwards adapt to changing conditions better than long-dated forwards
- As Angola’s financial market matures, more hedging instruments will become available
Common Mistakes
Hedging when you should not — If your income and expenses are both in Kwanza, you have natural hedging. Adding forward contracts creates risk rather than reducing it.
Over-hedging — Hedging more than your actual exposure creates a speculative position. Hedge only actual cash flows or portfolio exposures.
Ignoring the cost — The forward premium/discount is a real cost. In Angola, hedging Kwanza to USD costs approximately 8-10% annually (the interest rate differential). Factor this into your return calculations.
What’s Next
Forwards are just one type of derivative. The next lesson introduces broader derivatives concepts — options, futures, and their potential role in Angola’s developing market.
Next Lesson: Derivatives Concepts — Options, Futures, and Angola’s Future
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