Post on 21-Dec-2015
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -2
The Exposure Triangle
Transactions
Exposure
Transactions
Exposure
Translation
Exposure
Translation
ExposureEconomic
Exposure
Economic
Exposure
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -3
Case Study: Photronics
PHOTOMASKS
US DOLLARS
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -4
Case Study: Photronics
Photronics is the world's leading and fastest
growing manufacturer of photomasks.
Photomasks are high precision quartz plates that
contain microscopic images of electronic
circuits. A key element and enabling technology
in the manufacture of semiconductors,
photomasks are used to transfer circuit patterns
onto semiconductor wafers during the fabrication
of integrated circuits. They are produced in
accordance with circuit designs provided by
customers at strategically located manufacturing
facilities in North America, Europe and Asia.
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -5
Photronics’ International Business
”The globalization of the semiconductor industry has created significant
growth opportunities beyond Photronics' core market in North America.
Customers operating manufacturing facilities in Asia and Europe, as
well as North America, are streamlining their equipment and materials
procurement processes, relying on fewer and more capable suppliers.
“Photronics has made excellent progress in expanding its presence
around the world both by acquisitions and by the construction of new
facilities. During the year, new facilities were quickly brought to full
production in Manchester, England, and Austin, Texas, while additional
technological capability was installed in Singapore. These advanced
capabilities have elevated our strategic supplier status with many
significant customers who are now benefiting from our balanced
approach to international expansion and technology investments.
“ In Asia, our Singapore facility is benefiting from our customers'
utilization of wafer foundries, reflecting the increasing trend of
semiconductor manufacturers moving toward a fabless business
model. We believe that the number of companies utilizing foundries will
increase as they focus on their core strengths—designing
semiconductors and product marketing. Such a business model
transfers the risk associated with investing capital in production assets,
giving the now "fabless" semiconductor company additional flexibility
during down cycles, like the one affecting the semiconductor industry today.”
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Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -6
Case Study: Photronics
The company and its currency exposure Income, cash flow and translation
effects The economic risks
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Photronics’ International Acquisitions
?
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -10
Photronics: Translation Exposure
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Translation Policy
The Company's subsidiaries in Europe and Singapore maintain their accounts in their
respective local currencies. Assets and liabilities of such subsidiaries are translated to
U.S. dollars at year-end exchange rates. Income and expenses are translated at average
rates of exchange prevailing during the year. Foreign currency translation adjustments
are accumulated in a separate component of shareholders' equity. The effects of changes
in exchange rates on foreign currency transactions are included in income.
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -12
Balance SheetItem Prices
ExchangeRates
NetEffect
1. Fixed Assets
2. Inventories
3. Monetary Items
Exposed or Not Exposed?
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -14
Photronics: Cash Flow Exposure
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -15
Currency Risk: Economic Exposure
Change in the economic value of the firm resulting from unanticipated exchange rate changes.
Booked vs. anticipated transactions Expected vs. unexpected changes; the "cost
of hedging" Exposure and the parity assumptions: "We
are not exposed in the long run" Currency of denomination vs currency of
determination; compet., elasticities, etc.
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Economic Exposure
Economic exposure is how the firm’s revenues and costs will respond to exchange rate changes.Example: Even though Intel invoices German
customers in marks, its future revenues may be unaffected by fluctuations in the mark if the currency of determination of prices in the semiconductor business is the dollar or even the yen.
The currency of determination is the currency in which most of the competition prices similar products.
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -17
Operational Aspects of Exchange Risk
1.VOLUME EFFECTS (compensate for changes in profit margins)
2.PRICING FLEXIBILITY (change in margins to offset effect of exchange rate change)
3.DIVERSIFICATION of markets for inputs and outputs
4.FLEXIBILITY (ability to shift markets and sources quickly)
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -18
Translation vs Economic Exposure
Accounting exposure Exposure = "Exposed" assets - "exposed"
liabilities
Economic exposure Exposure = How will an unanticipated exchange
rate change affect the cash flows of the firm?Domestic salesExportsDomestic costs Import costs
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -19
A Realistic Approach
Banks versus corporations: To the extent that the firm is like a bank, do bank-style hedging. Match financial assets with liabilities of the same kind.
Seek to identify economic exposure using product cost-and-market analysis, industry competitive analysis, or statistical analysis on the sensitivity of the company’s value to exchange rate changes.
Hedge economic exposure using debt/swaps for long term exposure, short term instruments for uncertain exposure, and options for disaster insurance
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -20
Photronics: Economic Exposure
A/R INVENTORY PLANT
PHOTO-
MASKS
SOLD IN UK
INVOICED IN GBP GBP?
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Photronics: Economic Exposure
SOLD IN UK
INVOICED IN GBP
SOLD IN
WORLDWIDE MARKET
GBP?
USD?PHOTO-
MASKS
A/R INVENTORY PLANT
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Photronics: Economic Exposure
SOLD IN UK
INVOICED IN GBP
SOLD IN
WORLDWIDE MARKET
DETERMINED BY
COMPETITION
GBP?
USD?
JPY?
PHOTO-
MASKS
A/R INVENTORY PLANT
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -23
Summary: Types of Exposure
Transactions
Exposure
Transactions
Exposure
Translation
Exposure
Translation
ExposureEconomic
Exposure
Economic
Exposure
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -24
What Should Photronics Do?
Hedge, or suffer translation gains & losses? How can its exposure be gauged? What does FAS 133 imply for a company like
this? What tools should be used?
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Which Instrument?
Identifiableexposure
Debt, swaps,forward contracts
Uncertain exposure Instruments withflexibility, such asforwards and futures
Exposure thatthreatens financialdistress
Deep-out-of-the-money options
Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -26
UNDERSTANDING THE EXCHANGE
RISK MANAGEMENT PROBLEM Value of hedging Goals Nature of the business
UNDERSTANDING THE EXCHANGE
RISK MANAGEMENT PROBLEM Value of hedging Goals Nature of the business
MEASUREMENT OF EXPOSUREMEASUREMENT OF EXPOSURE
ACCOUNTINGACCOUNTING TRANSACTIONTRANSACTION ECONOMICECONOMIC
NATURE OF THE CASH FLOW EXPOSURE: One-shot? Linear? Contingent on exchange rates? Contingent on other events?
NATURE OF THE CASH FLOW EXPOSURE: One-shot? Linear? Contingent on exchange rates? Contingent on other events?
HEDGING METHODSHEDGING METHODS
OPERATIONALOPERATIONAL FINANCIALFINANCIAL
Linear Forwards Futures Debt Currency swaps
Linear Forwards Futures Debt Currency swaps
Exchange-rate
contingent Options Debt with option
features
Exchange-rate
contingent Options Debt with option
features
Contingent on
other events Event options Probability-based
hedging
Contingent on
other events Event options Probability-based
hedging
Examples: Sourcing flexibility Pricing strategy Market
diversification
Examples: Sourcing flexibility Pricing strategy Market
diversification
A Corporate Foreign Exchange Roadmap