Transaction Exposure G1

8/11/2019 Transaction Exposure G1

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Transaction exposure


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p

Types of Foreign Exchange

ExposureResulting from Accounting

Transaction Exposure

Impact of settling outstanding obligations

entered into before change in exchange rates

but to be settled after change in exchange

rates.

Translation Exposure

Changes in income and owners equity in

consolidated financial statements caused by a

change in exchange rates.

Resulting from Economics

Operating Exposure

Change in expected future cash flows arising

from an unexpected change in exchange rates

Changes in future cash flows arising from firm

and competitor firm responses

Time and Exchange Rate Changes


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Foreign exchange exposure is a

measure of how much the profitability,

net cash and market value for a firm

could change because of variations in

exchange rates.

Transaction exposure measure changes

in the value of outstanding financial

obligations incurred prior to a change

in exchange rates but not due to be

settled until after the exchange rates

change.


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Why Hedge?MNEs possess a multitude of cash flows that

are sensitive to change rates, interest rates,

and commodity price.

Hedging Defined

Many firms attempt to manage their

currency exposure through hendging, which

is the taking of a position, either acquiring a

cash flow, an asset, or a contract that will

rise (fall) in value and offset a fall (rise) in

the value of an existing position.

A firm that hedges its currency exposures

reduce the variance in the value of its future

expected cash flow.


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The Pros and Cons of HedgingPros Cons

Reduction in risk of future cash flows improvesthe planning capability of the firm

Shareholders are more capable of diversifyingcurrency risk than is the management of the firm

Reduction of risk in future cash flows reduces the

likelihood that the firms cash flows will fall

below a level sufficient to make debt-service

payments in order for its continued operation

Currency hedging does not increase the

expected cash flows of the firm

Management has a comparative advantage over

the individual shareholder in knowing the actual

currency risk of the firm

Management often conducts hedging activities

that benefit management at the expense of the

shareholders

Markets are usually in disequilibrium because ofstructural and institutional imperfections, as well

an unexpected external shocks

Managers can not outguess the market

Managements motivation to reduce variability is

sometimes driven by accounting reasons

Hedging would only add cost


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The Pros and Cons of Hedging


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Measurement of


Purchasing or selling on credit goods orservices when prices are stated in foreigncurrencies.

Borrowing or lending funds whenrepayment is to be made in a foreigncurrency.

Being a party to an unperformed foreign

exchange forward contract.

Otherwise acquiring assets or incurringliabilities denominated in foreigncurrencies .


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The Life of Transaction Exposure

The total transaction exposure consist of quotation, backlog,

and billing exposure.


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Hedging accounts receivable:

Exporters caseselling 90d in USD

Ac. Receivabl 1,000,000 USD 1,000,000 USD dollar payment

to be received in 3 months

January 2006 March 2006

Client pays us in USD


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Exporters case1st way:

Ac. Receivable 1,000,000 USD 1,000,000 USD dollar payment



3.305 S/./USD Spot Rate (Buy) 3.350 S/./USD Spot Rate March 06 (Buy) ?

3.307 S/./USD Spot Rate (Sell) 3.351 S/./USD Spot Rate March 06 (Sell) ?

3.311 Expected Rate March 06 (Buy)

3.312 Expected Rate March 06 (Sell )

1,000,000 USD

4) Receives S/. due to spot rate

3,350,000 S/. ?

3) Sales $ at spot rate on March 06

1,000,000 USD

2) Receives payment from buyer in USD

Unhedged


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Exporters case2nd way:

Hedge in the forward market




3.305 S/./USD Spot Rate (Buy)

3.307 S/./USD Spot Rate (Sell )

Annual 90 days I nterest Rates

Investment US Borrowing US Investment S/. Borrowing S/.

5.358% 5.858% 4.900% 5.160%

Forward contract ER for selling in 90 days: 3.305445187 S/. /USD

Sport Rate (Sell) (1+ER S/. borrowing)90/360

(1+ER $ investment)90/360

1,000,000 USD

4) Receives S/. due to forward sa le

3,305,445 S/.

3) Sales $ due to forward sale

1000000 USD

1) Enters a Forward Contract for selli ng $ in 90 days 2) Receives payment from buyer in


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Exporters case3rd way:

Hedge in the money market

Ac. Receivabl 1,000,000 USD 1,000,000 USD dollar payment



3.305 S/./USD Spot Rate (Buy) Annual 90 days Interest Rates WACC

3.307 S/./USD Spot Rate (Sell) Investment US Borrowing USD 10%

5.358% 5.858%

985,566 USD

1.1) Convert amount to S/. at spot rate 1,000,000 USD

3,257,297 S/. 4) Equivalent of amount borrowed 90 days

3,338,729 S/.

3) Pays loan in $ (principal + interest)

1000000 USD

1) Borrows $ in order to pay in 90 d (principal + interest) amount of Ac. Receivable

2) Receives payment from buyer in USD


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Exporters case4th way:Hedge in the options market





3.307 S/./USD Spot Rate (Sel l) 3.351 S/./USD Spot Rate March 06 (Sell) ?

Strike Premium Cost WACC

Put option (Right, no obligation to sell ) 3.306 0.701% (Size*Spot) 10%

1,000,000 USD 1,000,000 USD

If March 06 Exchange Rate < Strike

3,306,000 S/.

3) Excercise put option sell $

1.1) Pays premium cost of option in S/. 1000000 USD 3,282,253

23,168.05 S/. 5) Equivalent of premium cost 90 days

23,747 S/.

1,000,000 USD - 1,000,000

If March 06 Exchange Rate > Strike

3,350,000 S/. ?

3) Allow option to expire

1.1) Pays premium cost of option in S/. 0 1000000 3,326,253

23,168.05 S/. 5) Equivalent of premium cost 90 days

23,747 S/.

1) Purchase a put option on amount Ac Receivable in $ 2) Receives payment from buyer in USD

4) Exchange USD to S/. in spot market

2) Receives payment from buyer in USD1) Purchase a put option on amount Ac Receivable in $

4) Receive S/. due to put option


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Exporters caseComparison 4 ways:

Ac Receivable S/.

3,370,000 unhedged

3,360,000

3,350,000 put option

3,340,000

3,330,000 money market: 3,338,729

3,320,000

3,310,000

3,300,000 forward: 3,305,445

3,290,000

3,280,000 put option: 3,282,253

3,270,0003.27 3.28 3.29 3.30 3.31 3.32 3.33 3.34 3.35 3.36 3.37 Spot rate

3.305 Forward Rate

3.306 Strike Rate


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Hedging accounts payable:

Importers case paying 90d in USD

Ac. Payable 1,000,000 USD

January 2006 March 2006 1,000,000 USD dollar payment

to be made in 3 months

We pay to supplier in USD


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Importers case -1st way:

Unhedged






3.311 Expected Rate March 06 (Buy)

3.312 Expected Rate March 06 (Sell )

1,000,000 USD

3,351,000 S/. ?

4) Pays amount to supplier in USD

1,000,000 USD

2) Pays S/.at spot market

2) Receive $ at spot market


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Importers case -2nd way:

Hedge in the forward market




3.305 S/./USD Spot Rate (Buy)

3.307 S/./USD Spot Rate (Sell)

Annual 90 days Interest Rates

Investment US Borrowing US Investment S/. Borrowing S/.

5.358% 5.858% 4.900% 5.160%

Forward contract ER for buying in 90 days: 3.297497043 S/. /USD

Sport Rate (Buy) (1+ER S/. investment)90/360

(1+ER $ borrowing)90/360

1,000,000 USD

3,297,497 S/.

4) Pays amount to supplier in USD

1,000,000 USD

1) Enters a Forward Contract for buying $ in 90 days 2) Receive $ due to forward purchase

3) Pays S/. due to forward purchase


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Importers case -3rd way:

Hedge in the money market




3.305 S/./USD Spot Rate (Buy) Annua l 90 days I nteres t Rates WACC

3.307 S/./USD Spot Rate (Sell) Investment US Borrowing USD 10%

5.358% 5.858%

1,000,000 USD

1) Exchange S/. to $ at spot rate to invest in an account 1,000,000 USD4) Equival ent of amount invested 90 days

3,263,288 S/. 3,344,870 S/.

1.1) Invest in USD for 90 days period

986,782 USD

2) Receive $ due to investment in bank

3) Pays a mount to supplier in $

to receive (principal+interest) amount Ac.Payable


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Importers case -4th way:Hedge in the options market

Ac. Payabl e 1,000,000 USD





Strike Premium Cost WACC

Call option (Right, no obligation to buy) 3.306 0.701% (Size*Spot) 10%

1,000,000 USD

1,000,000 USD

3) Pays S/. For the option at strike

1.1) Pays premium cost of option in S/. 3,306,000 S/. 3,329,762

23,182.07 S/.

1,000,000 USD

5) Equivalent of premium cost 90 da ys

23,762 S/.

1,000,000 USD 2) Allow option to expire

If March 06 Exchange Rate < Strike

1,000,000 USD

1.1) Pays premium cost of option in S/. 3,302,000 S/. ? 3,325,762

23,182.07 S/.

1,000,000 USD

5) Equivalent of premium cost 90 da ys

23,762 S/.

3) Exchange S/. To USD in spot market

3) Pays amount to supplier in $

If March 06 Exchange Rate > Strike

2) Excercise call option to buy $

1) Purchase a call option on amount Ac Payable in $

4) Receive USD from spot market

4) Pays amount to supplier in $

1) Purchase a call option on amount Ac Payable in $


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Hedging accounts payable: Importers

caseComparison 4 ways:

Ac Payable S/.

3,370,000 unhedged

3,360,000

3,350,000

3,340,000 money market: 3,344,870

3,330,000

3,320,000 cal l option: 3,329,762

3,310,000 cal l option

3,300,000

3,290,000 forward: 3,297,497

3,280,000

3,270,000

3.27 3.28 3.29 3.30 3.31 3.32 3.33 3.34 3.35 3.36 3.37 Spot rate

3.297 Forward Rate

3.306 Strike Rate


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Companies have to deal with foreign exchange exposure, it is

the result of opening to world markets.

Hedging is a way to reduce the risk to this exposure, with its

advantages and disadvantages.

It could improve the capability of reaction of the company toforeign factors.

A firm that hedges its currency exposures reduce the variance

in the value of its future expected cash flow.

There are three alternatives to hedge against currencyexposure and there is the alternative of remain un-hedged. To

choose the best of the three alternatives the CFO has to own a

position on the future exchange rate.

Conclusions


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Thank you!!

Transaction Exposure G1

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