Managing Financial Risk: Case Study Prof. Ian Giddy New York University Treasury 2000 NYU/GTA.

Managing Financial Risk:Case Study

Prof. Ian GiddyNew York University

Treasury 2000

NYU/GTA

Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -2

The Exposure Triangle

Transactions

Exposure

Transactions

Exposure

Translation

Exposure

Translation

ExposureEconomic

Exposure

Economic

Exposure


Case Study: Photronics

PHOTOMASKS

US DOLLARS



Photronics is the world's leading and fastest

growing manufacturer of photomasks.

Photomasks are high precision quartz plates that

contain microscopic images of electronic

circuits. A key element and enabling technology

in the manufacture of semiconductors,

photomasks are used to transfer circuit patterns

onto semiconductor wafers during the fabrication

of integrated circuits. They are produced in

accordance with circuit designs provided by

customers at strategically located manufacturing

facilities in North America, Europe and Asia.


Photronics’ International Business

”The globalization of the semiconductor industry has created significant

growth opportunities beyond Photronics' core market in North America.

Customers operating manufacturing facilities in Asia and Europe, as

well as North America, are streamlining their equipment and materials

procurement processes, relying on fewer and more capable suppliers.

“Photronics has made excellent progress in expanding its presence

around the world both by acquisitions and by the construction of new

facilities. During the year, new facilities were quickly brought to full

production in Manchester, England, and Austin, Texas, while additional

technological capability was installed in Singapore. These advanced

capabilities have elevated our strategic supplier status with many

significant customers who are now benefiting from our balanced

approach to international expansion and technology investments.

“ In Asia, our Singapore facility is benefiting from our customers'

utilization of wafer foundries, reflecting the increasing trend of

semiconductor manufacturers moving toward a fabless business

model. We believe that the number of companies utilizing foundries will

increase as they focus on their core strengths—designing

semiconductors and product marketing. Such a business model

transfers the risk associated with investing capital in production assets,

giving the now "fabless" semiconductor company additional flexibility

during down cycles, like the one affecting the semiconductor industry today.”

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The company and its currency exposure Income, cash flow and translation

effects The economic risks


Photronics’ International Acquisitions

?


Sales and Asset Abroad

?


The Company’s Debt

?


Photronics: Translation Exposure


Translation Policy

The Company's subsidiaries in Europe and Singapore maintain their accounts in their

respective local currencies. Assets and liabilities of such subsidiaries are translated to

U.S. dollars at year-end exchange rates. Income and expenses are translated at average

rates of exchange prevailing during the year. Foreign currency translation adjustments

are accumulated in a separate component of shareholders' equity. The effects of changes

in exchange rates on foreign currency transactions are included in income.


Balance SheetItem Prices

ExchangeRates

NetEffect

1. Fixed Assets

2. Inventories

3. Monetary Items

Exposed or Not Exposed?


Photronics: Cash Flow Exposure


Currency Risk: Economic Exposure

Change in the economic value of the firm resulting from unanticipated exchange rate changes.

Booked vs. anticipated transactions Expected vs. unexpected changes; the "cost

of hedging" Exposure and the parity assumptions: "We

are not exposed in the long run" Currency of denomination vs currency of

determination; compet., elasticities, etc.


Economic Exposure

Economic exposure is how the firm’s revenues and costs will respond to exchange rate changes.Example: Even though Intel invoices German

customers in marks, its future revenues may be unaffected by fluctuations in the mark if the currency of determination of prices in the semiconductor business is the dollar or even the yen.

The currency of determination is the currency in which most of the competition prices similar products.


Operational Aspects of Exchange Risk

1.VOLUME EFFECTS (compensate for changes in profit margins)

2.PRICING FLEXIBILITY (change in margins to offset effect of exchange rate change)

3.DIVERSIFICATION of markets for inputs and outputs

4.FLEXIBILITY (ability to shift markets and sources quickly)


Translation vs Economic Exposure

Accounting exposure Exposure = "Exposed" assets - "exposed"

liabilities

Economic exposure Exposure = How will an unanticipated exchange

rate change affect the cash flows of the firm?Domestic salesExportsDomestic costs Import costs


A Realistic Approach

Banks versus corporations: To the extent that the firm is like a bank, do bank-style hedging. Match financial assets with liabilities of the same kind.

Seek to identify economic exposure using product cost-and-market analysis, industry competitive analysis, or statistical analysis on the sensitivity of the company’s value to exchange rate changes.

Hedge economic exposure using debt/swaps for long term exposure, short term instruments for uncertain exposure, and options for disaster insurance


Photronics: Economic Exposure

A/R INVENTORY PLANT

PHOTO-

MASKS

SOLD IN UK

INVOICED IN GBP GBP?



SOLD IN UK

INVOICED IN GBP

SOLD IN

WORLDWIDE MARKET

GBP?

USD?PHOTO-

MASKS

A/R INVENTORY PLANT



SOLD IN UK

INVOICED IN GBP

SOLD IN

WORLDWIDE MARKET

DETERMINED BY

COMPETITION

GBP?

USD?

JPY?

PHOTO-

MASKS

A/R INVENTORY PLANT


Summary: Types of Exposure

Transactions

Exposure

Transactions

Exposure

Translation

Exposure

Translation

ExposureEconomic

Exposure

Economic

Exposure


What Should Photronics Do?

Hedge, or suffer translation gains & losses? How can its exposure be gauged? What does FAS 133 imply for a company like

this? What tools should be used?


Which Instrument?

Identifiableexposure

Debt, swaps,forward contracts

Uncertain exposure Instruments withflexibility, such asforwards and futures

Exposure thatthreatens financialdistress

Deep-out-of-the-money options


UNDERSTANDING THE EXCHANGE

RISK MANAGEMENT PROBLEM Value of hedging Goals Nature of the business

UNDERSTANDING THE EXCHANGE

RISK MANAGEMENT PROBLEM Value of hedging Goals Nature of the business

MEASUREMENT OF EXPOSUREMEASUREMENT OF EXPOSURE

ACCOUNTINGACCOUNTING TRANSACTIONTRANSACTION ECONOMICECONOMIC

NATURE OF THE CASH FLOW EXPOSURE: One-shot? Linear? Contingent on exchange rates? Contingent on other events?

NATURE OF THE CASH FLOW EXPOSURE: One-shot? Linear? Contingent on exchange rates? Contingent on other events?

HEDGING METHODSHEDGING METHODS

OPERATIONALOPERATIONAL FINANCIALFINANCIAL

Linear Forwards Futures Debt Currency swaps

Linear Forwards Futures Debt Currency swaps

Exchange-rate

contingent Options Debt with option

features

Exchange-rate

contingent Options Debt with option

features

Contingent on

other events Event options Probability-based

hedging

Contingent on

other events Event options Probability-based

hedging

Examples: Sourcing flexibility Pricing strategy Market

diversification

Examples: Sourcing flexibility Pricing strategy Market

diversification

A Corporate Foreign Exchange Roadmap


Ian Giddy

Ian H. Giddy

NYU Stern School of Business

44 West 4th Street, New York, NY 10012

Tel 212-998-0332; Fax 212-995-4233

[email protected]

http://www.giddy.org

Managing Financial Risk: Case Study Prof. Ian Giddy New York University Treasury 2000 NYU/GTA.

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