Stage 2 — Model Specification

Objective

• The design discipline professionals apply before building any model that others must audit
• The actual logic of the forward, money-market, and option hedges, specified in named-range notation
• How to write for an AI reader: ambiguity here becomes a wrong workbook in Stage 3

Learn — why the spec comes before the build

The CFO said "yes, build it." Before you (or your AI) open Excel, Treasury wants a design document it can review, because a model built without a spec is a model nobody else can audit. Your Stage 3 build will follow this document to the letter: every weakness in the spec becomes a defect in the build, which you will then have to find and fix in the audit. The better the spec, the shorter the audit.

And here's the AI-era reason this matters even more than the audit story: in Stage 3 you don't describe the workbook to an AI and hope: the spec is the prompt. A precise spec tells the model exactly what to build and exactly what each result must equal, so the first build comes back close and the audit becomes verification, not archaeology. A vague spec produces the opposite: the AI confidently builds the wrong thing, and you discover your real requirements one frustrating tweak at a time. Every minute you spend making this document unambiguous is a round of corrective back-and-forth you don't pay for in Stage 3.

Do — write the eight required sections

Learn — the named-range contract

These ten names are the shared vocabulary of your spec, the workbook, the automated checks, and every LLM prompt in this project. Use them exactly:

Learn — the calculation flow you're specifying

1 · Forward hedge — one line

USD proceeds = FC_AMT × F0_in

Locked. Done. The rest of the model exists to tell you whether locking was the right call.

2 · Money-market hedge — three explicit steps

Step 1  Borrow FC today:      Borrow = FC_AMT / (1 + R_FC × T_DAYS/360)
        (sized so the receivable exactly repays the loan at settlement)
Step 2  Convert at spot:      USD_now = Borrow × S0_in
Step 3  Invest in USD:        Proceeds = USD_now × (1 + R_USD × T_DAYS/360)

Specify each step as its own cell: the audit (and any auditor) wants the pipeline visible, not a single nested formula.

3 · The parity check — your free error detector

Covered interest rate parity says a forward contract and the borrow-convert-invest pipeline are the same trade built two ways, so:

F_implied = S0_in × (1 + R_USD × T/360) / (1 + R_FC × T/360)   ≈   F0_in

Write this into §7 as a validation rule: if MM proceeds and forward proceeds differ by more than rounding, the build has a formula error. This check catches any formula error that breaks the parity between the two hedges.

4 · Option hedge (put floor)

Net proceeds at settlement spot S_T:
  = FC_AMT × max(S_T, K_PUT)  −  FC_AMT × PREM_PUT

Below the strike, the put pays the difference (floor holds). Above it, the option expires worthless and you sell at the better market rate, minus the premium you already paid either way. Specify the call's participation payoff the same way.

Do — write conceptual formulas, not cell equations

✗ "C7 = C4/(1+C5*C6/360)"                        ← dies with the workbook
✓ "Compute the FC borrowing amount by dividing
   FC_AMT by (1 + R_FC × T_DAYS/360); this sizes
   the loan so the receivable repays it exactly
   at settlement."                                ← buildable in any tool

The named-range layer is what makes your logic portable between a document, Excel, and an AI prompt. Cell addresses are an implementation detail; the names are the model.

Do — you draft, AI reviews, then you iterate together

Write the first draft of the spec yourself, from your brief and the scenario. Then have an AI review it (ask it to find the gaps, not to tell you it's good) and work the fixes through with it, accepting some suggestions and rejecting others on the record. Log prompts in prompt-log.md and show at least one specific iteration: a gap found in your draft and how you fixed it (a before/after note or annotated diff). "The AI's review found my draft omitted the rate basis; I added ACT/360 to §4 and to every rate row in §2" is exactly the evidence the brief asks for.

Deliverable

• Started from the template-spec.md
• All 8 sections present; 2–3 pages, no filler
• Named-range contract complete: all ten names, placeholder values, units, Stage-4 sources
• Placeholders explicitly flagged "indicative, replaced with live data at Stage 4"
• Every tab named with its purpose (Cover, Legend/Key, Inputs, per-hedge calcs, Sensitivity, Notes)
• Calculation flow in named-range notation: zero cell addresses; MM hedge in three steps
• Sensitivity plan fully specified (±5%, 1% steps, chart purpose stated)
• Validation rules concrete: parity check, no error cells, every output a formula
• prompt-log.md shows at least one specific draft→fix iteration
• Committed as capabilities/fx-hedging/spec.md, and the folder's README.md updated

Check yourself