Shan Pin Yi Michael Utama Suphakit Sae-Ue Chanunya Pimpla Finance 570 IFC Manufacturing-Foreign...

Shan Pin Yi

Michael Utama

Suphakit Sae-Ue

Chanunya Pimpla

Finance 570

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IFC Manufacturing-Foreign Exchange Hedging

Agenda

Company Background IFC’s Expansion to Mexico Basie Issue and Immediate Issue Cause and Effect Diagram IFC’s Exposure Evaluate IFC’s Portfolio Hedging

Instruments Recommendation

Company Background

Canadian based company. Specialized in producing the parts used in the

production of automobiles in North American. Seatbelt. Airbag.

Two Significant Trends of IFC Increased use of outsourcing in North American

automobile manufacturing. Focusing on automobile safety invention.

Company Background

IFC’s operation based upon the implementation of proprietary technology.

No American plants owned before 1997. All U.S. acquisitions took place in 1997. IFC’s acquisition strategy is based on

large and efficiency scale that are result of the proprietary technology.

Key Person

Herve Villa IFC’s founder and CEO. Ph.D in mechanical engineering. Entrepreneur profile and hand off

owner. Got contracts with Big Three car

companies: GM, Ford, and Chrysler.

Construct production facility in Mexico.

Key Person

John Trudel Former treasurer and CFO. Expert in using financial derivatives. Often, Guest speaker at the Treasury

Management Association of Canada’s regional meetings.

Had free hand in the choice of hedging structure.

Quit IFC in July 1997.

Key Person

Bob Young Present treasury and CFO. Joined IFC in November 1997. Worked at Treasury department for 15

years. Expert in accounting role. However, had no experience in aspect of

new job at IFC.

IFC’s Expansion to Mexico

Financial crisis of Asian Foreign exchange market and equity markets

Spread to other developing countries quickly. Weaken Mexican peso position against to

Canadian Dollars. IFC wants to build the plant in Mexico. Need to get financing from the Manufacture

Bank of New York. Proposed value : 826,000,000 mexican pesos

(MXP).

Basic Issues

Immediate Issues

Cause/Effect diagram

Time Line

Translation Exposure

U.S dollar

Assets Liabilities Net Exposure

62,877,000 300,000,000 237,123,000

Transaction ExposureNet U.S. Dollar Exporsure from Transactions (in US$000s)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec38,654 12,566 6,340 8,587 4,028 (10,726) (150) 9,985 16,714 20,910 24,177 19,636

U.S. Dollar Receipts (in US$000s)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecFord 28,312 9,826 9,114 8,745 6,112 5,348 3,824 8,336 9,878 10,028 14,114 15,750 GM 5,008 6,114 1,838 2,256 1,782 876 742 736 4,924 6,996 7,236 9,338 Chrysler 12,662 5,566 4,962 5,360 3,625 3,478 3,876 9,089 11,112 13,108 12,144 16,727 Honda 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 Saturn 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700

Total 51,982 27,506 21,914 22,361 17,519 15,702 14,442 24,161 31,914 36,132 39,494 47,815

U.S. Dollar Payables (in US$000s)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecSalary 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 9,108 Debt Service - - - - - 12,000 - - - - - 12,000 Materials 7,114 8,726 9,360 7,560 7,277 8,214 8,378 7,962 8,986 9,008 9,103 7,071

Total 13,328 14,940 15,574 13,774 13,491 26,428 14,592 14,176 15,200 15,222 15,317 28,179

Hedging Instruments

Forward contract Plain Vanilla Options Exotic Options

Single Barrier Options Double Barrier Options Average Rate Options Range Binary Options Swing Forward Options

1998Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec AVG

Forward 1.370 1.360 1.380 1.392 1.401 0 0 1.366 1.359 1.351 1.347 1.291 1.362Forecast 1.422 1.420 1.418 1.415 1.415 1.410 1.410 1.410 1.410 1.410 1.410 1.397 1.412Real Rate 1.441 1.433 1.417 1.430 1.445 1.466 1.487 1.535 1.522 1.545 1.540 1.543 1.484Expected Expected Rate Cdn$ 1.3000 per U.S. dollar 1.300

1.338 1.366

1.3001.250

1.300

1.350

1.400

1.450

1.500

1.550 Ja

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Jan

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Feb

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Mar

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Historical Foreign Exchange RatesCanadian dollars per on U.S. dollar

Real Rate Forward Forcast Expected

In 1996, Speculators were looking for Cdn$ 1.3000 per

U.S. Dollar and below.

Asian foreign exchange and equity

markets melted down Crisis occurred in the

summer of 1997.

Trudel left the company in July

1997.

“Obviously was looking at the

wrong fundamental”

Source: www.x-rates.com

1.338 1.366

1.410

1.3001.250

1.300

1.350

1.400

1.450

1.500

1.550 Ja

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May

96

Jun

96

Jul 9

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Sep

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Oct

96

No

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96

Jan

97

Feb

97

Mar

97

Ap

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7M

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7Ju

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Au

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7Se

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De

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May

98

Jun

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Jul 9

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Sep

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Oct

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No

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1.338

1.535

1.366

1.410

1.3001.250

1.300

1.350

1.400

1.450

1.500

1.550 Ja

n 9

6Fe

b 9

6M

ar 9

6A

pr

96

May

96

Jun

96

Jul 9

6A

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96

Sep

96

Oct

96

No

v 9

6D

ec

96

Jan

97

Feb

97

Mar

97

Ap

r 9

7M

ay 9

7Ju

n 9

7Ju

l 97

Au

g 9

7Se

p 9

7O

ct 9

7N

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De

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8Fe

b 9

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98

May

98

Jun

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Jul 9

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98

Sep

98

Oct

98

No

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98






Forward Contract

57.7% Over Hedge in March Total 12.0% Over Hedge

1998 Net Exposure Forward Over Hedge Under Hedge % Over Hedge

Jan 38.66 45.00 6.34 16.4%Feb 12.57 15.00 2.43 19.3%Mar 6.34 10.00 3.66 57.7%Apr 8.59 10.00 1.41 16.4%May 4.03 5.00 0.97 24.1%JunJulAug 10.01 10.00Sep 16.72 15.00 -1.72Oct 20.91 25.00 4.09 19.6%Nov 24.18 25.00 0.82 3.4%Dec 19.64 5.00 -14.64

Total 161.65 165.00 19.72 -16.36 12.0%

1998 Forward Forecast Real Rate 1998 Net Exposure Forward Over Hedge Under Hedge % Over Hedge

Jan 1.370 1.422 1.441 Jan 38.66 45.00 6.34 16.4%Feb 1.360 1.420 1.433 Feb 12.57 15.00 2.43 19.3%Mar 1.380 1.418 1.417 Mar 6.34 10.00 3.66 57.7%Apr 1.392 1.415 1.430 Apr 8.59 10.00 1.41 16.4%May 1.401 1.415 1.445 May 4.03 5.00 0.97 24.1%Jun 1.410 1.466 JunJul 1.410 1.487 JulAug 1.366 1.410 1.535 Aug 10.01 10.00Sep 1.359 1.410 1.522 Sep 16.72 15.00 -1.72Oct 1.351 1.410 1.545 Oct 20.91 25.00 4.09 19.6%Nov 1.347 1.410 1.540 Nov 24.18 25.00 0.82 3.4%Dec 1.291 1.397 1.543 Dec 19.64 5.00 -14.64

AVG 1.362 1.412 1.484 Total 161.65 165.00 19.72 -16.36 12.0%

Forward Contract Possible Profits/Losses

Forecast Rates Real Rates Expected Rate Cdn$ 1.3000 per U.S. dollar

1998 Net Exposure Over Hedge Under Hedge Total Net Exposure Over Hedge Under Hedge Total Net Exposure Over Hedge Under Hedge Total

Jan -2.00 -0.33 -2.33 -2.74 -0.45 -3.19 2.71 0.44 3.15Feb -0.75 -0.14 -0.89 -0.92 -0.18 -1.10 0.76 0.15 0.90Mar -0.24 -0.14 -0.38 -0.23 -0.13 -0.37 0.51 0.29 0.80Apr -0.21 -0.03 -0.24 -0.33 -0.05 -0.38 0.79 0.13 0.91May -0.06 -0.01 -0.07 -0.18 -0.04 -0.22 0.41 0.10 0.50Jun

Jul

Aug -0.44 -0.43 -1.69 -1.68 0.66 0.66Sep -0.85 0.09 -0.76 -2.72 0.28 -2.44 0.98 -0.10 0.88Oct -1.22 -0.24 -1.46 -4.05 -0.79 -4.85 1.07 0.21 1.28Nov -1.52 -0.05 -1.57 -4.67 -0.16 -4.83 1.14 0.04 1.18Dec -2.09 1.56 -0.53 -4.96 3.70 -1.26 -0.18 0.14 -0.05

Total -9.37 -0.95 1.65 -8.67 -22.50 -1.81 3.98 -20.33 8.84 1.36 0.04 10.23

Plain Vanilla Option

IFC’s transaction exposure is long position.

IFC purchased Canada Call. Gave them the right to sell U.S dollar

and buy Canadian dollars at the strike price 1.40.

1998 Vanilla Option Forecast Real Rate 1998 Net Exposure Vanilla Option

Jan 1.422 1.441 Jan 38.66Feb 1.420 1.433 Feb 12.57Mar 1.418 1.417 Mar 6.34Apr 1.415 1.430 Apr 8.59May 1.415 1.445 May 4.03Jun 1.410 1.466 Jun -10.73Jul 1.410 1.487 Jul -0.15Aug 1.400 1.410 1.535 Aug 10.01 5.00Sep 1.400 1.410 1.522 Sep 16.72 5.00Oct 1.410 1.545 Oct 20.91Nov 1.410 1.540 Nov 24.18Dec 1.400 1.397 1.543 Dec 19.64 15.00

AVG 1.400 1.412 1.484 Total 150.77 25.00

Vanilla Option Possible Profits/Losses

1998 Forecast Rates Real Rates Expected Rate Cdn$ 1.3000 per U.S. dollarJan

Feb

Mar

Apr

May

Jun

Jul

Aug -0.05 -0.62 0.55Sep -0.05 -0.56 0.55Oct

Nov

Dec 0.04 -2.19 1.46

Total -0.06 -3.38 2.56

Range Binary

A double barrier binary option with knock-in and knock-out triggers.

Binary option in which the payout is all or nothing. IFC would get $10 million if and only if

neither foreign exchange rates of 1.3750 nor 1.4750 trade before the end of March 1998.

Premium: US $ 1.47 million. Fact: Neither rates did trade. Result: IFC got US$ 10 million.

Swing Forward

Zero cost at inception. Combination of buying a call and selling

a put or buying a put and selling a call at the same strike price.

Contains single barrier knock-in written option.

IFC’s Portfolio

Possible Profits/Losses (in U.S.$ Million )

Forecast Rates Real Rates Expected Rate Cdn$ 1.3000 per U.S. dollar

Forward Contract -8.67 -20.33 +10.23

Vanilla Option - - +2.56

Range Binary +10.00 +10.00 -

Swing Forward - - -

Total +1.33 -10.33 +12.79

Evaluation

Over-hedge translation exposure. Exotic options seem to be speculation. Lack of internal controls. Lack of financial risk measurement

program such as Value at risk (VaR). Lack of efficient computer system. Similar to a hedge fund trading portfolio

more than a corporate’s hedging schedule.

Recommendation

Implement Value-at-Risk measurement. Invest in advanced computer systems. Do not over-hedging. Predictable event, use forward contract. Unpredictable event, use option. Combine hedging strategy.

Recommendation

Develop clear risk management policy. Specify a detailed risk management

philosophy with procedures and controls. Use of derivatives should consistent with

overall risk management and capital policy approved by board of directors and senior management.

Risk limit policies and monitor of transactions.

Disclose information about their use of derivatives.

THANK YOU

Shan Pin Yi Michael Utama Suphakit Sae-Ue Chanunya Pimpla Finance 570 IFC Manufacturing-Foreign...

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