Hedging: yer doin' it wrong!

Companies throughout Latin America, but especially in Brazil and Mexico have collectively lost billions of dollars when their use of financial derivatives to bet against the US dollar turned out badly.

The WSJ has details:

"Throughout Latin America, companies are telling investors they have lost millions, in some cases billions, of dollars due to foreign- exchange gambles that, in some cases, had little to do with their core businesses.

For now, however, such losses appear to be most widespread in Brazil and Mexico. In Brazil, the growing list of blue-chip casualties includes paper-pulp giant Aracruz Celulose SA and industrial conglomerate Grupo Votorantim. In Mexico, trading in tortilla maker Gruma's stock was halted earlier this month after its potential losses mounted to $684 million.

The surprise disclosures have sent stock prices tumbling, and regulators in both countries are investigating whether companies adequately disclosed their trading risks to investors.

Some local reports have speculated that the damage in Brazil alone could exceed $30 billion and may affect two hundred companies.

The bad bets were made using currency derivatives -- contracts tied to the value of the U.S. dollar. Companies lost badly when the dollar shot up in value starting in early September as investors cashed out of investments in emerging markets, fleeing to safer havens. And as companies raced to close out their positions they forced local currencies to tumble still further."

At least one company started out correctly using futures to hedge their business exposure to exchange rate fluctuations but got tired of "losing money" that way and decided to go into the gambling business:"

"Executives at Comercial Mexicana, whose stores sell digital cameras, TVs and other imported products, had protected itself against exchange-rate fluctuations by buying up dollars on futures markets. But, in recent months, with the peso's continuing rise, that insurance proved costly.

So, starting during the summer, Comercial Mexicana's treasury department stopped buying dollars as insurance and instead began laying bets against the U.S. currency, according to people familiar with the matter.

The retailer, along with other companies, made the bets using currency contracts sold by big banks, including J.P. Morgan Chase & Co. and Barclays PLC, both of which declined to comment.

Under the deals, the banks offered financing and currency trades at favorable rates. But there was a hitch. If the U.S. dollar strengthened beyond a certain threshold, then the companies would have to sell dollars at a loss. In some cases, the contracts had triggers that doubled the number of dollars the companies owed.

Comercial Mexicana purchased the contracts from five different banks. At first, the deals were profit makers.

But when the company's finance chief, Francisco Martinez de la Vega, returned from a two-week European vacation on Oct. 1, he found a situation spiraling out of control.

By then, investors panicked over the widening financial crisis had begun pulling money out of Mexico and other emerging markets. Since Aug. 1, the peso has dropped 24% against the dollar, and in October careened through its biggest daily drops since a 1994 currency crisis.

Comercial Mexicana suddenly faced huge losses. Mr. de la Vega had to call in bankers from Credit Suisse over the weekend of Oct. 4 to help him analyze the situation. The total cost to close the position: $1.4 billion".