Foreign Exchange Risk Management (Currency Risk Management)
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Transcript of Foreign Exchange Risk Management (Currency Risk Management)
INTERNATIONAL FINANCE FORE IGN EXCHANGE (CURRENCY) R ISK
MANAGEMENT amp STRATEGIES FOR MANAGING REL ATED
EXPOSURES
Hisham Ahmed Rizvi
hishamrzvgmailcom
+91-9999171299
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
2
INTRODUCTIONbull Risks faced by a firmbull What is financial riskbull What is currency risk
bull Exposure amp risk Are they samebull Measuring exposurebull Measuring risk
bull Why should risk be managed
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
3
RISKS FACED BY A FIRM
Core
B
usi
ness
R
isks
Unsuccessful product launch
Labour problems
Cyclical demand fluctuations
Material supply problems
And so forthEnvir
onm
en
tal R
isks
Exchange rate fluctuationsInterest rate fluctuations
Sudden price rise of goods
Shifts in government policies
And so forth
bull Peculiar to a firm
bull All pervasive and affect all firms in an
industry
bull Financial risks are a subset of
environmental risks
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
4
WHAT IS FINANCIAL RISK
Financial Risk
Credit risk Concentration risk
Market risk
Interest rate risk
Currency risk
Equity risk
Commodity risk
Liquidity risk
Refinancing risk
Operational risk
Legal risk
Model risk
Political risk
Valuation risk
FINANCIAL RISK
Financial risk refers to the chance that an investments actual return will be different than expected It basically is exposure to the danger of financial loss on investments made by investors
RISKA situation involving exposure to danger
SOURCE Oxford Dictionary
SOURCE Investopedia
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
5
WHAT IS CURRENCY RISK
For example if you are a US investor and you have stocks in Canada the return that you will realize is affected by both the change in the price of the stocks and the change in the value of the Canadian dollar against the US dollar So if you realize a 15 return in your Canadian stocks but the Canadian dollar depreciates 15 against the US dollar this will amount to no gain at all
CURRENCY RISK
It is a form of financial risk that arises from the change in price of one currency against another Whenever investors or companies have assets or business operations across national borders they face currency risk (or foreign exchange risk)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
6
EXPOSURE amp RISK ARE THEY SAMEIN FINANCIAL CONTEXT
For example between April 1992 and July 1995 the exchange rate between rupee and US dollar was rock steady For an Indian firm involved in exports and imports from US this meant that it had significant exposure to this exchange rate (because the exchange rate could have affected its performance) but it did not perceive significant risk because the exchange rate was stable
EXPOSURE
It is the measure of the sensitivity of a firmrsquos performance to fluctuations in the relevant risk factor ie whether or not a certain risk factor affects a firms performance
Each firm is ldquoexposedrdquo to unforeseen changes in a number of variables in its environment These variables are called Risk Factors Eg Exchange rate fluctuation is a risk factor
RISK
It is the measure of the extent of variability of the performance attributable to the risk factor ie how much does a risk factor affect a firms performance
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
2
INTRODUCTIONbull Risks faced by a firmbull What is financial riskbull What is currency risk
bull Exposure amp risk Are they samebull Measuring exposurebull Measuring risk
bull Why should risk be managed
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
3
RISKS FACED BY A FIRM
Core
B
usi
ness
R
isks
Unsuccessful product launch
Labour problems
Cyclical demand fluctuations
Material supply problems
And so forthEnvir
onm
en
tal R
isks
Exchange rate fluctuationsInterest rate fluctuations
Sudden price rise of goods
Shifts in government policies
And so forth
bull Peculiar to a firm
bull All pervasive and affect all firms in an
industry
bull Financial risks are a subset of
environmental risks
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
4
WHAT IS FINANCIAL RISK
Financial Risk
Credit risk Concentration risk
Market risk
Interest rate risk
Currency risk
Equity risk
Commodity risk
Liquidity risk
Refinancing risk
Operational risk
Legal risk
Model risk
Political risk
Valuation risk
FINANCIAL RISK
Financial risk refers to the chance that an investments actual return will be different than expected It basically is exposure to the danger of financial loss on investments made by investors
RISKA situation involving exposure to danger
SOURCE Oxford Dictionary
SOURCE Investopedia
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
5
WHAT IS CURRENCY RISK
For example if you are a US investor and you have stocks in Canada the return that you will realize is affected by both the change in the price of the stocks and the change in the value of the Canadian dollar against the US dollar So if you realize a 15 return in your Canadian stocks but the Canadian dollar depreciates 15 against the US dollar this will amount to no gain at all
CURRENCY RISK
It is a form of financial risk that arises from the change in price of one currency against another Whenever investors or companies have assets or business operations across national borders they face currency risk (or foreign exchange risk)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
6
EXPOSURE amp RISK ARE THEY SAMEIN FINANCIAL CONTEXT
For example between April 1992 and July 1995 the exchange rate between rupee and US dollar was rock steady For an Indian firm involved in exports and imports from US this meant that it had significant exposure to this exchange rate (because the exchange rate could have affected its performance) but it did not perceive significant risk because the exchange rate was stable
EXPOSURE
It is the measure of the sensitivity of a firmrsquos performance to fluctuations in the relevant risk factor ie whether or not a certain risk factor affects a firms performance
Each firm is ldquoexposedrdquo to unforeseen changes in a number of variables in its environment These variables are called Risk Factors Eg Exchange rate fluctuation is a risk factor
RISK
It is the measure of the extent of variability of the performance attributable to the risk factor ie how much does a risk factor affect a firms performance
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
3
RISKS FACED BY A FIRM
Core
B
usi
ness
R
isks
Unsuccessful product launch
Labour problems
Cyclical demand fluctuations
Material supply problems
And so forthEnvir
onm
en
tal R
isks
Exchange rate fluctuationsInterest rate fluctuations
Sudden price rise of goods
Shifts in government policies
And so forth
bull Peculiar to a firm
bull All pervasive and affect all firms in an
industry
bull Financial risks are a subset of
environmental risks
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
4
WHAT IS FINANCIAL RISK
Financial Risk
Credit risk Concentration risk
Market risk
Interest rate risk
Currency risk
Equity risk
Commodity risk
Liquidity risk
Refinancing risk
Operational risk
Legal risk
Model risk
Political risk
Valuation risk
FINANCIAL RISK
Financial risk refers to the chance that an investments actual return will be different than expected It basically is exposure to the danger of financial loss on investments made by investors
RISKA situation involving exposure to danger
SOURCE Oxford Dictionary
SOURCE Investopedia
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
5
WHAT IS CURRENCY RISK
For example if you are a US investor and you have stocks in Canada the return that you will realize is affected by both the change in the price of the stocks and the change in the value of the Canadian dollar against the US dollar So if you realize a 15 return in your Canadian stocks but the Canadian dollar depreciates 15 against the US dollar this will amount to no gain at all
CURRENCY RISK
It is a form of financial risk that arises from the change in price of one currency against another Whenever investors or companies have assets or business operations across national borders they face currency risk (or foreign exchange risk)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
6
EXPOSURE amp RISK ARE THEY SAMEIN FINANCIAL CONTEXT
For example between April 1992 and July 1995 the exchange rate between rupee and US dollar was rock steady For an Indian firm involved in exports and imports from US this meant that it had significant exposure to this exchange rate (because the exchange rate could have affected its performance) but it did not perceive significant risk because the exchange rate was stable
EXPOSURE
It is the measure of the sensitivity of a firmrsquos performance to fluctuations in the relevant risk factor ie whether or not a certain risk factor affects a firms performance
Each firm is ldquoexposedrdquo to unforeseen changes in a number of variables in its environment These variables are called Risk Factors Eg Exchange rate fluctuation is a risk factor
RISK
It is the measure of the extent of variability of the performance attributable to the risk factor ie how much does a risk factor affect a firms performance
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
4
WHAT IS FINANCIAL RISK
Financial Risk
Credit risk Concentration risk
Market risk
Interest rate risk
Currency risk
Equity risk
Commodity risk
Liquidity risk
Refinancing risk
Operational risk
Legal risk
Model risk
Political risk
Valuation risk
FINANCIAL RISK
Financial risk refers to the chance that an investments actual return will be different than expected It basically is exposure to the danger of financial loss on investments made by investors
RISKA situation involving exposure to danger
SOURCE Oxford Dictionary
SOURCE Investopedia
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
5
WHAT IS CURRENCY RISK
For example if you are a US investor and you have stocks in Canada the return that you will realize is affected by both the change in the price of the stocks and the change in the value of the Canadian dollar against the US dollar So if you realize a 15 return in your Canadian stocks but the Canadian dollar depreciates 15 against the US dollar this will amount to no gain at all
CURRENCY RISK
It is a form of financial risk that arises from the change in price of one currency against another Whenever investors or companies have assets or business operations across national borders they face currency risk (or foreign exchange risk)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
6
EXPOSURE amp RISK ARE THEY SAMEIN FINANCIAL CONTEXT
For example between April 1992 and July 1995 the exchange rate between rupee and US dollar was rock steady For an Indian firm involved in exports and imports from US this meant that it had significant exposure to this exchange rate (because the exchange rate could have affected its performance) but it did not perceive significant risk because the exchange rate was stable
EXPOSURE
It is the measure of the sensitivity of a firmrsquos performance to fluctuations in the relevant risk factor ie whether or not a certain risk factor affects a firms performance
Each firm is ldquoexposedrdquo to unforeseen changes in a number of variables in its environment These variables are called Risk Factors Eg Exchange rate fluctuation is a risk factor
RISK
It is the measure of the extent of variability of the performance attributable to the risk factor ie how much does a risk factor affect a firms performance
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
5
WHAT IS CURRENCY RISK
For example if you are a US investor and you have stocks in Canada the return that you will realize is affected by both the change in the price of the stocks and the change in the value of the Canadian dollar against the US dollar So if you realize a 15 return in your Canadian stocks but the Canadian dollar depreciates 15 against the US dollar this will amount to no gain at all
CURRENCY RISK
It is a form of financial risk that arises from the change in price of one currency against another Whenever investors or companies have assets or business operations across national borders they face currency risk (or foreign exchange risk)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
6
EXPOSURE amp RISK ARE THEY SAMEIN FINANCIAL CONTEXT
For example between April 1992 and July 1995 the exchange rate between rupee and US dollar was rock steady For an Indian firm involved in exports and imports from US this meant that it had significant exposure to this exchange rate (because the exchange rate could have affected its performance) but it did not perceive significant risk because the exchange rate was stable
EXPOSURE
It is the measure of the sensitivity of a firmrsquos performance to fluctuations in the relevant risk factor ie whether or not a certain risk factor affects a firms performance
Each firm is ldquoexposedrdquo to unforeseen changes in a number of variables in its environment These variables are called Risk Factors Eg Exchange rate fluctuation is a risk factor
RISK
It is the measure of the extent of variability of the performance attributable to the risk factor ie how much does a risk factor affect a firms performance
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
6
EXPOSURE amp RISK ARE THEY SAMEIN FINANCIAL CONTEXT
For example between April 1992 and July 1995 the exchange rate between rupee and US dollar was rock steady For an Indian firm involved in exports and imports from US this meant that it had significant exposure to this exchange rate (because the exchange rate could have affected its performance) but it did not perceive significant risk because the exchange rate was stable
EXPOSURE
It is the measure of the sensitivity of a firmrsquos performance to fluctuations in the relevant risk factor ie whether or not a certain risk factor affects a firms performance
Each firm is ldquoexposedrdquo to unforeseen changes in a number of variables in its environment These variables are called Risk Factors Eg Exchange rate fluctuation is a risk factor
RISK
It is the measure of the extent of variability of the performance attributable to the risk factor ie how much does a risk factor affect a firms performance
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
7
MEASURING EXPOSURE
IMPORTANT TERMS TO UNDERSTAND IN THIS DEFINITION
bull Functional currency It is the primary currency of the firm in which its financial statements are published It is often the domestic currency of their country
bull Real value Values adjusted for inflation (In practice though it becomes difficult to adjust all values with an uncertain inflation rate hence nominal values are only used)
bull Unanticipated changes Only unanticipated changes in the relevant risk factor are to be considered because the market already makes allowances for anticipated changes For eg an exported invoicing a foreign buyer in the buyerrsquos currency will build an allowance for the expected depreciation of that currency This is anticipated change However if the depreciation is more than expected that becomes unanticipated change
Exposure of a firm to a risk factor is the sensitivity of the real value of the firmrsquos assets liabilities or operating income expressed in its functional currency to unanticipated changes in the risk factor
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
8
MEASURING EXPOSURE
For example suppose the price of a pound sterling in terms of rupees right now (also called spot rate) is Rs 6800 while the one month forward rate is Rs 6820 However one month later the spot rate turns out to be Rs 6830
In this case the anticipated depreciation is 20 paise per pound in one month while the unanticipated depreciation has been 10 paise per pound
Q How do we separate a given change in the risk factor into anticipated and unanticipated components
Ans One possible way is by using forward rate
FORWARD RATE
A rate applicable to a financial transaction that will take place in the future
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
9
MEASURING EXPOSUREAN EXAMPLEA firm has a 90-day payable amounting to US $500000 arising out of raw material import transaction Current spot rate is Rs 4060 per dollar 3-month forward rate is Rs 4080 per dollar Actual rate 3 months later turns out to be Rs 4100 per dollar
bull Therefore the unanticipated depreciation of rupee is Rs 020 per dollar
bull The loss on account of increase in rupee value of the payable is (500000020) = Rs 100000
According to the 3-month forward rate the firm would have paid (4080500000) = Rs 20400000
But actually it will pay (41500000) = Rs 20500000
Rs 100000 extra on account of unanticipated depreciation of rupee
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
10
MEASURING EXPOSUREAN EXAMPLEOne straightforward way to define exposure is ldquoBy how much will the value of the payable change if the rupee-dollar rate changes by 1 rupee per dollarrdquo
In this case the value of the payable changes by 100000 on a 20 paise change of rupee-dollar rate therefore it will change by 500000 for a rupee change
Note here that the exposure is here is same as the value of the foreign currency (500000)
A general rule is that if the foreign currency value of the exposed item is fixed exposure identically equals that value
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
11
MEASURING RISK
For example we have the following forecast by a financial consulting outfitldquoIn our view the most likely value of the spot rate three months from now is Rs 4100 per dollar but it could be as high as Rs 4150 There is a small probability that the dollar could fall to Rs 3940rdquo
Risk is the measure of the extent of variability of the performance attributable to the risk factor (eg exchange rate) It depends on the size of the exposure and the extent of fluctuations expected in the risk factor (eg exchange rate) In simple words risk gives us a range within which the variation due to the risk factor can take place It can be arrived by analyzing the best-case and worst-case scenarios for a firm
Scenario Best-case Worst-case
3-month spot rate Rs 3940 Rs 4150
Rupee outlay to settle the payable
Rs 19700000
Rs 20750000
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
12
WHY SHOULD RISK BE MANAGEDLeads to lower demand for returns by investorsbull Investors can manage unsystematic risks (peculiar to a
company) by diversifying their portfolio (eg by buying stocks in oil as well as aviation industry) but they have no control over systematic risks (related to the industry and economy at large) Hence greater the systematic risk greater is the return demanded by investorsEnsures better cash flows
bull If the various risks associated with a firm are managed properly it will ensure a steady and healthy cash flow for the firm thereby ensuring that it takes full advantage of good investment opportunities
External financing can be avoidedbull If risk is managed effectively it will lead to ready
availability of internal funds for investments and lower the reliance on external funds like debt and new equity which are always less preferred and more risky
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
13
WHY SHOULD RISK BE MANAGED
Financial distress can be avoidedbull If not managed properly the risks associated with a firm
can lead to a liquidity crunch This will lead to the bankers customers employees and suppliers to believe there is financial distress and they may react in way which will affect future cash flows of the firm
Creation of ldquocorporate valuerdquobull Firms enhance shareholder wealth ndash create ldquocorporate
valuerdquo ndash by making good investments in areas of product development RampD advertising promotion etc This is possible only with a steady stream of cash flows
Increased investor confidencebull A firm that manages its risk effectively and consistently
over a period of time is well reputed by investors and bankers and considered creditworthy This ensures availability of credit when and if required
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
14
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
15
WHAT IS HEDGING
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
16
HEDGINGbull What is hedging
bull To hedge or not to hedge
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
17
TO HEDGE OR NOT TO HEDGEbull Hedging is the taking of a position either acquiring a cash flow or an asset or a contract (including a forward contract) that will rise (or fall) in value to offset a fall (or rise) in value of an existing position
bull Hedging therefore protects the owner of the existing asset from loss (but it also eliminates any gain resulting from changes in exchange rates on the value of the exposure)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
18
TO HEDGE OR NOT TO HEDGE
Opponents of Hedging
Stockholders are much more capable of diversifying currency risk than the management of the firm
Currency risk management does not add value to the firm and it incurs costs
Hedging might benefit corporate management more than shareholders
Proponents of Hedging
Reduction in risk in future cash flows improves the planning capability of the firm
Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firm
Reduction of risk in future cash flows reduces the likelihood that the firmrsquos cash flows will fall below a necessary minimum
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
19
CURRENCY EXPOSUREbull Transactions exposurebull Translation exposurebull Operating exposurebull Economic exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
20
TYPES OF CURRENCY EXPOSURES
Currency Exposure
Short-TermAccounting
(Translation
Exposure)
Cash Flow
Unanticipated
Changes
(Transactions
Exposure)
Anticipated
Changes
Long-Term
Operating Exposure
Strategic Exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
21
TYPES OF CURRENCY EXPOSURES Changes in exchange rate can affect firm value through
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
17
TO HEDGE OR NOT TO HEDGEbull Hedging is the taking of a position either acquiring a cash flow or an asset or a contract (including a forward contract) that will rise (or fall) in value to offset a fall (or rise) in value of an existing position
bull Hedging therefore protects the owner of the existing asset from loss (but it also eliminates any gain resulting from changes in exchange rates on the value of the exposure)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
18
TO HEDGE OR NOT TO HEDGE
Opponents of Hedging
Stockholders are much more capable of diversifying currency risk than the management of the firm
Currency risk management does not add value to the firm and it incurs costs
Hedging might benefit corporate management more than shareholders
Proponents of Hedging
Reduction in risk in future cash flows improves the planning capability of the firm
Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firm
Reduction of risk in future cash flows reduces the likelihood that the firmrsquos cash flows will fall below a necessary minimum
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
19
CURRENCY EXPOSUREbull Transactions exposurebull Translation exposurebull Operating exposurebull Economic exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
20
TYPES OF CURRENCY EXPOSURES
Currency Exposure
Short-TermAccounting
(Translation
Exposure)
Cash Flow
Unanticipated
Changes
(Transactions
Exposure)
Anticipated
Changes
Long-Term
Operating Exposure
Strategic Exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
21
TYPES OF CURRENCY EXPOSURES Changes in exchange rate can affect firm value through
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
18
TO HEDGE OR NOT TO HEDGE
Opponents of Hedging
Stockholders are much more capable of diversifying currency risk than the management of the firm
Currency risk management does not add value to the firm and it incurs costs
Hedging might benefit corporate management more than shareholders
Proponents of Hedging
Reduction in risk in future cash flows improves the planning capability of the firm
Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firm
Reduction of risk in future cash flows reduces the likelihood that the firmrsquos cash flows will fall below a necessary minimum
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
19
CURRENCY EXPOSUREbull Transactions exposurebull Translation exposurebull Operating exposurebull Economic exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
20
TYPES OF CURRENCY EXPOSURES
Currency Exposure
Short-TermAccounting
(Translation
Exposure)
Cash Flow
Unanticipated
Changes
(Transactions
Exposure)
Anticipated
Changes
Long-Term
Operating Exposure
Strategic Exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
21
TYPES OF CURRENCY EXPOSURES Changes in exchange rate can affect firm value through
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
19
CURRENCY EXPOSUREbull Transactions exposurebull Translation exposurebull Operating exposurebull Economic exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
20
TYPES OF CURRENCY EXPOSURES
Currency Exposure
Short-TermAccounting
(Translation
Exposure)
Cash Flow
Unanticipated
Changes
(Transactions
Exposure)
Anticipated
Changes
Long-Term
Operating Exposure
Strategic Exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
21
TYPES OF CURRENCY EXPOSURES Changes in exchange rate can affect firm value through
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
20
TYPES OF CURRENCY EXPOSURES
Currency Exposure
Short-TermAccounting
(Translation
Exposure)
Cash Flow
Unanticipated
Changes
(Transactions
Exposure)
Anticipated
Changes
Long-Term
Operating Exposure
Strategic Exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
21
TYPES OF CURRENCY EXPOSURES Changes in exchange rate can affect firm value through
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
21
TYPES OF CURRENCY EXPOSURES Changes in exchange rate can affect firm value through
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
22
TYPES OF CURRENCY EXPOSURESILLUSTRATIVE EXAMPLES
A Taiwanese company has the following USD exposures1 Owns a factory in Texas worth US$5 million2 Agreement to buy goods worth US$2 million3 Biggest competitor is a US company
What happens if the NT dollar appreciates4 NT$ value of US factory goes down (translation)5 NT$ cost of buying goods goes down (transaction)6 Global competitiveness of Taiwanese company
decreases (operating)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
23
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
24
TRANSLATION EXPOSURE
bull Translation exposure is the potential for an increase or decrease in the parentrsquos net worth and reported net income caused by a change in exchange rates since the last translation
bull The accounting process of translation involves converting these foreign subsidiaries financial statements into home currency-denominated statements
bull It is the exposure on assets and liabilities appearing in the balance sheet but which are not going to be liquidated in the foreseeable future
bull It has no direct impact on cash flows of a firm
TRANSLATION EXPOSURE
Translation exposure also called Accounting Exposure or Balance Sheet exposure arises because financial statements of foreign subsidiaries ndash which are stated in foreign currency ndash must be restated in the parentrsquos reporting currency for the firm to prepare consolidated financial statements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
25
TRANSLATION EXPOSUREbull No cash gains or losses are involved but translation exposure affects the published financial statements and hence may affect market valuation of the parent companys stock
Indian company law does not require translation and consolidation of foreign subsidiaries financial statements with those of the parent company unless the foreign operations are an integral part of the parent business for eg a branchbull However major stock exchanges require it as one of their listing requirements
bull As more and more Indian firms are going multinational they are increasingly considering translation and consolidation of foreign subsidiaries and hence are becoming vulnerable to translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
26
TRANSLATION EXPOSURE AN EXAMPLEAN INDIAN COMPANY WITH A UK SUBSIDIARY
Particular
March 31 2012 (pound1=Rs85)
March 31 2013(pound1=Rs70)
Value in pound Translated value
Value in pound
Translated value
Real Estate
pound1000000 Rs 85000000 pound950000 Rs
66500000
Inventories pound200000 Rs 17000000 pound250000 Rs
17500000
Cash pound150000 Rs 12750000 pound160000 Rs 11200000
Total pound1350000
Rs 102000000
pound1360000
Rs 95200000
Financial details of UK Subsidiary
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
27
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational
exposure
Regardless of which method is employed a translation method must not only designate at what exchange rate individual balance sheet and income statement items are remeasured but also designate where any imbalance is to be recorded (current income or an equity reserve account)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
28
CURRENTNONCURRENT METHODbull The underlying principle is that assets and liabilities should be translated based on their maturity
Current assets (like Cash) translated at the spot rate eg DM2=$1
Noncurrent assets (like Net Fixed Assets) translated at the historical rate in effect when the item was first recorded on the books eg DM3=$1
Balance Sheet Local Currency
Current Noncurrent
Cash 2100 DM $1050 Inventory 1500 DM $750 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2800 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $600 Common stock 2700 DM $900 Retained earnings 900 DM $700CTA -------- --------Total Liabilities and
Equity6600 DM $2800
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
29
MONETARYNONMONETARY METHODbull The underlying principle is that monetary accounts have a similarity because their value represents a sum of money whose value changes as the exchange rate changes
bull All monetary balance sheet accounts (cash marketable securities accounts receivable etc) of a foreign subsidiary are translated at the current exchange rate eg DM2=$1
All other (nonmonetary) balance sheet accounts (common stock) are translated at the historical exchange rate in effect when the account was first recorded egDM3=$1
Balance Sheet Local Currency
Monetary Nonmonetary
Cash 2100 DM $1050 Inventory 1500 DM $500 Net fixed assets 3000 DM $1000
Total Assets 6600 DM $2550 Current liabilities 1200 DM $600 Long-Term debt 1800 DM $900 Common stock 2700 DM $900 Retained earnings 900 DM $0CTA -------- --------Total Liabilities and
Equity6600 DM $2400
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
30
TEMPORAL METHODbull The underlying principle is that assets and liabilities should be translated based on how they are carried on the firmrsquos books
bull Balance sheet accounts are translated at the current spot exchange rate if they are carried on the books at their current value
bull Items that are carried on the books at historical costs are translated at the historical exchange rates in effect at the time the firm placed the item on the books
bull Gains or losses resulting from remeasurement are carried directly to current consolidated income and not to equity reserves (increased variability of consolidated earnings)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
31
CURRENT RATE METHODbull All balance sheet items (except for stockholderrsquos equity) are translated at the current exchange rate
DM2=$1
bull Very simple method in application
bull The biggest advantage of the current rate method is that the gain or loss on translation does not pass through the income statement but goes directly to a reserve account (reducing variability of reported earnings)
Balance Sheet Local Currency
Current Rate
Cash DM2100 $1050 Inventory DM1500 $750 Net fixed assets DM3000 $1500
Total Assets DM6600 $3300 Current liabilities DM1200 $600 Long-Term debt DM1800 $900 Common stock DM2700 $900 Retained earnings DM900 $360 CTA -------- $540
Total Liabilities and Equity
DM6600 $3300
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
32
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
Spot exchange rate
earnings
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
33
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Book value of inventory
at spot exchange rate
Book value of
inventory historic
rate
Current value of inventory at spot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
34
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 historic
ratespot exchange rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
35
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 spot rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
36
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
spot ratehistorical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
37
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
historical rate
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
38
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300
From income statement
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
39
Balance Sheet Local Currency
Current Noncurrent
Monetary Nonmonetary
Temporal Current Rate
Cash 2100 DM $1050 $1050 $1050 $1050 Inventory 1500 DM $750 $500 $900 $750 Net fixed assets 3000 DM $1000 $1000 $1000 $1500
Total Assets 6600 DM $2800 $2550 $2950 $3300 Current liabilities
1200 DM $600 $600 $600 $600
Long-Term debt
1800 DM $600 $900 $900 $900
Common stock 2700 DM $900 $900 $900 $900 Retained earnings
900 DM $700 $150 $550 $360CTA -------- -------- -------- -------- $540
Total Liabilities and
Equity
6600 DM $2800 $2550 $2950 $3300 Under the current rate method a ldquoplugrdquo equity account named
cumulative translation adjustment makes the balance sheet balance
earnings
HOW VARIOUS TRANSLATION METHODS DEAL WITH A CHANGE FROM DM3 TO DM2 = $1
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
40
TRANSLATION EXPOSUREbull Introduction amp example
bull Methodsbull Strategies to manage translational exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
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MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
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MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
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OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
41
MANAGING TRANSLATION EXPOSUREBALANCE SHEET HEDGE
bull To create a balance sheet hedge once transaction exposure has been controlled often means creating new transaction exposure Hence this is not always a very wise option
BALANCE SHEET HEDGE
It involves equating the amount of exposed assets in an exposure currency to exposed liabilities in that currency so that the net exposure is zero
bull Two common methods used for managing translation exposure are called balance sheet hedge and derivates hedge
HEDGEMaking an investment to reduce or control risk Investors use this strategy when they are unsure of what the market will do
bull In simple language a hedge is used to reduce any substantial lossesgains A hedge can be constructed from many types of financial instruments including stocks derivative products futures contracts etc
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
42
MANAGING TRANSLATION EXPOSUREDERIVATIVES HEDGE
bull Derivatives allow risk related to the price of the underlying asset to be transferred from one party to another
DERIVATIVES
A derivative is a financial contract which derives its value from the performance of another entity such as an asset index or interest rate called the underlying
bull For example a wheat farmer and a miller could sign a futures contract to exchange a specified amount of cash for a specified amount of wheat in the future
bull Both parties have reduced a future risk for the wheat farmer the uncertainty of the price and for the miller the availability of wheat
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
43
SHOULD FIRMS HEDGE TRANSLATION EXPOSURE
YES- Investors donrsquot have enough information to estimate cash flows and instead must rely on reported earnings- If reported earnings are distorted by translation issues investors will misvalue the firm
NO- The value of the firm is the PV of cash flows- Translation exposure doesnrsquot effect cash flows so we should ignore it
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
44
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
45
TRANSACTION EXPOSURE
bull It stems from the possibility of incurring exchange gains or losses on transactions already entered into and denominated in a foreign currency
bull Transaction exposure is short term in nature
bull It has a direct impact on cash flows of a firm
TRANSACTION EXPOSURE
The risk faced by companies involved in international trade that currency exchange rates will change after the companies have already entered into financial obligations
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
46
TRANSACTION EXPOSUREEXAMPLESbull A currency has to be converted in order to make or receive a payment for goods or services on a particular date in future
bull A currency has to be converted to repay a loan or make an interest payment on a particular date in future
bull A currency has to converted to make a dividend payment royalty payment etc whose foreign currency amount is fixed
For eg suppose a firm receives an export order It fixes a price manufactures the product makes the shipment and gives 90 days credit to the buyer who will pay in his currency
Then the company has transaction exposure from the time it accepts the order till the time the payment is received and converted to home currency
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
47
TRANSACTION EXPOSUREEXAMPLES
bull Transaction exposure arises because of the risk that the US seller will receive something other than $1620000
bull If the euro weakens to $08500euro then Trident will receive $1530000
bull If the euro strengthens to $09600euro then Trident will receive $1728000
bull Thus exposure is the chance of either a loss or a gain
Suppose a US firm Trident sells merchandise on account to a Belgian buyer for euro1800000 payment to be made in 60 days (S0 = $090euro)
The US seller expects to exchange the euro1800000 for $1620000 when payment is received
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
48
TRANSACTION EXPOSUREbull Introduction amp example
bull Strategies to manage transaction exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
49
MANAGING TRANSACTION EXPOSURE
Strategies
Contractual Hedges
Forward Market Hedge
Money Market Hedge
Options Market Hedge
Futures Market Hedge
Financial Hedges
Swaps
Operating Strategies
Risk Shifting
Price adjustment clauses
Exposure Netting
Risk Sharing
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
50
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
bull If you are going to owe a foreign currency on future agree to buy the foreign currency now by entering into long position in a forward contract
bull If you are going to receive a foreign currency on future agree to sell the foreign currency now by entering into short position in a forward contract
FORWARD MARKET
An over-the-counter marketplace that sets the price of a financial instrument or asset for future delivery Contracts entered into in the forward market are binding on the parties involved
The buying of a security such as a stock commodity or currency with the expectation that the asset will rise in value is called long position
The sale of a borrowed security commodity or currency with the expectation that the asset will fall in value is called short position
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
51
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGEEXAMPLE You are a US importer of British woolens and you have just ordered next yearrsquos inventory Payment of pound100M is due in one year How can you fix the cash outflow in dollars
Answer One way is to put yourself in a position that delivers pound100M in one year ndash a long forward contract on the pound
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
52
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
53
MANAGING TRANSACTION EXPOSUREFORWARD MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
54
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEbull To hedge a foreign currency payable buy the foreign currency today amphold it1 Buy the present value of the foreign currency payable today2 Invest that amount at the foreign rate3 At maturity your investment will have grown enough to cover for your
foreign currency payableA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Can hedge this payable by buying euro9615385 = euro100000(104) today and investing it at 4 in Italy for one year
At maturity he will have euro100000 = euro9615385(104)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
55
MANAGING TRANSACTION EXPOSUREMONEY MARKET HEDGEA US based importer of Italian bicycles What can he do in this situationbull In one year owes euro100000 to an Italian supplierbull The spot exchange rate is $125 = euro100bull The one year interest rate in Italy is 4
Dollar cost today = $12019231 = euro9615385
With this money market hedge we have redenominated a one-year euro100000 payable into a $12019231 payable due today
If the US interest rate is 3 we could borrow$12019231 today and owe it in one year
$12379808 = $12019231 (103)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
56
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGEbull To hedge a foreign currency payable buy calls on the
currencybull If the call currency appreciates your call option lets
you buy the currency at the exercise price of the call
bull To hedge a foreign currency receivable buy puts on the currencybull If the currency depreciates your put options lets you
sell the currency for the exercise price
OPTIONS
An option is a contract that gives the buyer the right but not the obligation to buy or sell an underlying asset at a specific price on or before a certain date
Two types of options are bull A call gives the holder the right to buy an asset at a certain
price within a specific period of time bull A put gives the holder the right to sell an asset at a certain
price within a specific period of time
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
57
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
58
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
59
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
60
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
61
MANAGING TRANSACTION EXPOSUREOPTIONS MARKET HEDGE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
62
MANAGING TRANSACTION EXPOSUREFUTURES MARKET HEDGEbull Futures contracts are one of the most common derivatives used to hedge risk The main reason that companies or corporations use future contracts is to offset their risk exposures and limit themselves from any fluctuations in price
bull When a company knows that it will be making a purchase in the future for a particular item it should take a long position in a futures contract to hedge its position
bull If a company knows that it will be selling a certain item it should take a short position in a futures contract to hedge its position
FUTURES CONTRACT
A futures contract is as an arrangement between two parties to buy or sell an asset at a particular time in the future for a particular price
bull Futures market hedge is similar to hedging with forwards
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
63
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Shifting
bull Strategy for risk shiftingbull Denominating exports in a strong currencybull Denominating imports in a weak currency
bull Outcome depends onbull Bargaining power or parties involvedbull Competitiveness of firmrsquos particular business
Exposure Nettingbull Offsetting exposures in one currency with exposures in the same or another currency when exchange rates are expected to move in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure
bull A firmrsquos currency exposures can be viewed as a portfoliobull Exposure netting depends on the correlation between
currencies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
64
MANAGING TRANSACTION EXPOSUREOPERATING STRATEGIESRisk Sharingbull Both parties reach agreement to share the currency risk
associated with a dealbull Risk sharing arrangements
bull Price adjustment clausebull Neutral zonebull Outside neutral zoneCurrency Collars
bull Providing protection if the currency moves outside an agreed-on range This agreement is arrived on both parties at the time of the financial deal
Leading and Lagging
bull leading (accelerate timing of depreciating currency)bull lagging (delay timing of appreciating currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
65
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
66
OPERATING EXPOSURE
bull Measuring the operating exposure of a firm requires forecasting and analyzing all the firmrsquos future individual transaction exposures together with the future exposures of all the firmrsquos competitors and potential competitors worldwide
bull Operating exposure is far more important for the long-run health of a business than changes caused by transaction or translation exposure
OPERATING EXPOSURE
Operating exposure also called economic exposure competitive exposure and even strategic exposure on occasion measures any change in the present value of a firm resulting from changes in future operating cash flows caused by an unexpected change in exchange rates
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
67
ATTRIBUTES OF OPERATING EXPOSUREbull The cash flows of a multinational firm can be divided into operating cash flows and financing cash flows
bull Operating cash flows arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables rent and lease payments royalty and license fees and assorted management fees
bull Financing cash flows are payments for loans (principal and interest) equity injections and dividends of an inter and intracompany nature
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
68
FINANCIAL amp OPERATING CASH FLOWS BETWEEN PARENT amp SUBSIDIARY
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
69
MEASURING THE IMPACT OF OPERATING EXPOSURE An unexpected change in exchange rates impacts a firmrsquos expected cash flows at four levels depending on the time horizon used Short run
Medium run Equilibrium case
Medium run Disequilibrium case
Long run
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
70
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The first level impact is on the one-year operating budget the gain or loss depends on the currency of denomination (currency of expected cash flows)
bull In the short run it is difficult to change the exposure due to implied obligations such as purchase or sales commitments because the currency of denomination cannot be changed
bull It is also difficult to change sales prices or to renegotiate factor costs
SHORT RUN IMPACT
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
71
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull The second level impact is on expected medium-term cash flows
bull If parity conditions hold the firm should be able to adjust prices and factor costs over time to maintain the expected level of cash flows if no real variables have changed
bull The country of cash flow origination and its monetary fiscal and balance of payments policies will determine whether firms can adjust prices and costs
bull Example If Volvo is selling cars to Germany and the DM depreciates because the German money supply rises Volvo will be protected if it can raise its DM prices so that the Krona price is maintained
MEDIUM RUN ndash PARITY CONDITIONS HOLD
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
72
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull If the firm is not able to adjust prices and costs because the change in exchange rates has been accompanied by real changes so that relative prices have been altered
bull Example If the DM has depreciated relative to the Krona because German investors have lost confidence in the German economy and are moving their capital to Sweden the wealth of German investors has dropped the real price of a Swedish car has risen and Volvo may not be able to raise its prices proportionately There is less than perfect pass-through
MEDIUM RUN ndash CHANGE IN REAL VARIABLES
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
73
MEASURING THE IMPACT OF OPERATING EXPOSURE
bull Long-run cash flows beyond five years could be affected Cash flows will be influenced by the reactions of existing and potential competitors to exchange rate changes when real variables are affected
bull In principle all firms subject to international competition domestic or multinational are subject to foreign exchange operating exposure in the long run whenever real variables are affected
LONG RUN
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
74
OPERATING EXPOSUREAN EXAMPLE
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
75
OPERATING EXPOSUREbull Introduction amp example
bull Strategies to manage operating exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
76
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull The objective of both operating and transaction exposure management is to anticipate and influence the effect of unexpected changes in exchange rates on a firmrsquos future cash flows rather than merely hoping for the best
bull To meet this objective management can diversify the firmrsquos operating and financing base
bull Management can also change the firmrsquos operating and financing policies
bull If a firmrsquos operations are diversified internationally management is prepositioned both to recognize disequilibrium when it occurs and to react competitively
bull Recognizing a temporary change in worldwide competitive conditions permits management to make changes in operating strategies
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
77
MANAGEMENT OF OPERATING EXPOSURE STRATEGIC DIVERSIFICATIONbull If a firmrsquos financing sources are diversified it will be prepositioned to take advantage of temporary deviations from the international Fisher effect
bull However to switch financing sources a firm must already be well-known in the international investment community
bull Again this would not be an option for a domestic firm (if it has limited its financing to one capital market)INTERNATIONAL FISHER EFFECTAn economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries nominal interest rates for that time
Calculated as E represents the change in the exchange ratei1 represents country As interest ratei2 represents country Bs interest rate
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
78
MANAGEMENT OF OPERATING EXPOSURE Operating and transaction exposures can be partially managed by adopting operating or financing policies that offset anticipated foreign exchange exposures
The four most commonly employed proactive policies areMatching currency cash flows
Risk-sharing agreements
Back-to-back or parallel loans
Currency swaps
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
79
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS EXAMPLE
A US firm has continuing export sales to Canada
In order to compete effectively in Canadian markets the firm invoices all export sales in Canadian dollars
This policy results in a continuing receipt of Canadian dollars month after month
This endless series of transaction exposures could be continually hedged with forwards or other contractual agreements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
80
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWS
Exposure The sale of goods to Canada creates a foreign currency exposure from the inflow of Canadian dollarsHedge The Canadian dollar debt payments act as a financial hedge by requiring debt service an outflow of Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
81
MANAGEMENT OF OPERATING EXPOSUREMATCHING CURRENCY CASH-FLOWSOne way to offset an anticipated continuous long exposure to a particular company is to acquire debt denominated in that currency (matching)
Another alternative would be for the US firm to seek out potential suppliers of raw materials or components in Canada as a substitute for US or other foreign firms
In addition the company could engage in currency switching in which the company would pay foreign suppliers with Canadian dollars
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
82
MANAGEMENT OF OPERATING EXPOSURERISK SHARING AGREEMENTS Currency Clauses Risk-SharingAn alternate method for managing a long-term cash flow exposure between firms is risk sharing
This is a contractual arrangement in which the buyer and seller agree to ldquosharerdquo or split currency movement impacts on payments between them
This agreement is intended to smooth the impact on both parties of volatile and unpredictable exchange rate movements
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
83
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS Back-to-Back LoansA back-to-back loan also referred to as a parallel loan or credit swap occurs when two business firms in separate countries arrange to borrow each otherrsquos currency for a specific period of time
At an agreed terminal date they return the borrowed currencies
Such a swap creates a covered hedge against exchange loss since each company on its own books borrows the same currency it repays
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
84
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS
The back-to-back loan provides a method for parent-subsidiary cross-border financing without incurring direct currency exposure
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
85
MANAGEMENT OF OPERATING EXPOSUREBACK TO BACK LOANS There are two fundamental impediments to widespread use of the back-to-back loan It is difficult for a firm to find a partner termed a counterparty for the currency amount and timing desired
A risk exists that one of the parties will fail to return the borrowed funds at the designated maturity ndash although each party has 100 collateral (denominated in a different currency)
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
86
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS Currency SwapsA currency swap resembles a back-to-back loan except that it does not appear on a firmrsquos balance sheet
In a currency swap a firm and a swap dealer or swap bank agree to exchange an equivalent amount of two different currencies for a specified amount of time
For Example
A Japanese corporation and US corporation would like to enter into a cross currency swap which would allow them to use foreign currency cash inflows to service debt
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
87
MANAGEMENT OF OPERATING EXPOSURECURRENCY SWAPS
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
-
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
88
MANAGEMENT OF OPERATING EXPOSUREOTHER STRATEGIESbull Use of Marketing Strategies
bull Market Selectionbull Pricing StrategyProduct Strategybull Promotional Strategy
bull Use of Production Managementbull Input mixbull Plant Location amp Shifting production among
plantsbull Raising Productivity (ie lowering costs)
bull Financial Hedging techniques may also be used
INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
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INTERNATIONAL FINANCE PRESENTATION | HISHAM AHMED RIZVI | HISHAMRZVGMAILCOM
89
THANK YOUARUSHI SHARMA |
arushisharma888gmailcomDIVIK GIRDHAR | divikgirdhargmailcom
DIVYA GUPTA | guptadivya2310gmailcom
- International finance Foreign exchange (Currency) risk managem
- Slide 2
- Risks faced by a firm
- What is FINANCIAL risk
- What is currency risk
- Exposure amp risk are they same In Financial context
- Measuring exposure
- Measuring exposure (2)
- Measuring exposure An Example
- Measuring exposure An Example (2)
- Measuring Risk
- Why should risk be managed
- Why should risk be managed (2)
- Slide 14
- What is hedging
- Slide 16
- To hedge or not to hedge
- To hedge or not to hedge (2)
- Slide 19
- Types of currency exposures
- Types of currency exposures (2)
- Types of currency exposures (3)
- Slide 23
- Translation exposure
- Translation exposure (2)
- Translation exposure An Example An Indian Company with a Uk
- Slide 27
- CurrentNoncurrent Method
- MonetaryNonmonetary Method
- Temporal method
- Current rate method
- How Various Translation Methods Deal with a Change from DM3 to
- How Various Translation Methods Deal with a Change from DM3 to (2)
- How Various Translation Methods Deal with a Change from DM3 to (3)
- How Various Translation Methods Deal with a Change from DM3 to (4)
- How Various Translation Methods Deal with a Change from DM3 to (5)
- How Various Translation Methods Deal with a Change from DM3 to (6)
- How Various Translation Methods Deal with a Change from DM3 to (7)
- How Various Translation Methods Deal with a Change from DM3 to (8)
- Slide 40
- Managing Translation exposure Balance sheet hedge
- Managing Translation exposure derivatives hedge
- Should Firms Hedge Translation Exposure
- Slide 44
- Transaction exposure
- Transaction exposure Examples
- Transaction exposure Examples (2)
- Slide 48
- Managing Transaction Exposure
- Managing Transaction Exposure Forward market hedge
- Managing Transaction Exposure Forward market hedge (2)
- Managing Transaction Exposure Forward market hedge (3)
- Managing Transaction Exposure Forward market hedge (4)
- Managing Transaction Exposure money market hedge
- Managing Transaction Exposure money market hedge (2)
- Managing Transaction Exposure Options market hedge
- Managing Transaction Exposure Options market hedge (2)
- Managing Transaction Exposure Options market hedge (3)
- Managing Transaction Exposure Options market hedge (4)
- Managing Transaction Exposure Options market hedge (5)
- Managing Transaction Exposure Options market hedge (6)
- Managing Transaction Exposure FUTURES market hedge
- Managing Transaction Exposure Operating strategies
- Managing Transaction Exposure Operating strategies (2)
- Slide 65
- OPERATING exposure
- ATTRIBUTES OF OPERATING exposure
- Financial amp Operating Cash Flows Between Parent amp Subsidiary
- Measuring the impact of OPERATING exposure
- Measuring the impact of OPERATING exposure (2)
- Measuring the impact of OPERATING exposure (3)
- Measuring the impact of OPERATING exposure (4)
- Measuring the impact of OPERATING exposure (5)
- OPERATING exposure An example
- Slide 75
- Management of Operating Exposure strategic Diversification
- Management of Operating Exposure strategic Diversification (2)
- Management of Operating Exposure
- Management of Operating Exposure Matching currency cash-flows
- Management of Operating Exposure Matching currency cash-flows (2)
- Management of Operating Exposure Matching currency cash-flows (3)
- Management of Operating Exposure Risk sharing agreements
- Management of Operating Exposure back to back loans
- Management of Operating Exposure back to back loans (2)
- Management of Operating Exposure back to back loans (3)
- Management of Operating Exposure CURRENCY SWAPS
- Management of Operating Exposure CURRENCY SWAPS (2)
- Management of Operating Exposure OTHER STRATEGIES
- Slide 89
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