Download - final exposure mgmt 1
-
8/8/2019 final exposure mgmt 1
1/30
EXPOSURE MANAGEMENT
GROUP NO: 8
MEMBER ROLL NO.
Mohit Jain 30
Priyanka Kabra 33 Ankit Shah 80
Chirag Shah 81
Dhaval Shah 82
-
8/8/2019 final exposure mgmt 1
2/30
INTERNATIONAL FINANCE
y Foreign exchange risk E.g., an unexpected devaluation adversely affects your export
market
Political risk E.g., an unexpected overturn of the government that jeopardizes
existing negotiated contracts
y Market imperfections
E.g., trade barriers and tax incentives may affect location ofproduction
y Expanded opportunity sets E.g., raise funds in global markets, gains from economies of
scale
-
8/8/2019 final exposure mgmt 1
3/30
Case: Global treasury management at Proctor
& Gamble
60% ofP &Gs revenues from international salesProducts sold in 130 countries
Has centralized global treasury management function
Management of all foreign exchange transactions
P& G trades currency between subsidiaries, cuttingout banks and saving on transaction costs
Subsidiaries can invest in and borrow money fromotherP &G entities instead of dealing with banks
-
8/8/2019 final exposure mgmt 1
4/30
FOREIGN EXCHANGE EXPOSURE
DEFINITION
Foreign exchange exposure is the risk of a firm's
profitability and net cash flow to potentially change due
to a change in exchange rates.
EXAMPLE -
-
8/8/2019 final exposure mgmt 1
5/30
STRATEGIES FOR REDUCING EXCHANGE
RISK
OPTIONS
FORWARD CONTRACTS
HEDGING
-
8/8/2019 final exposure mgmt 1
6/30
Managing Foreign Exchange Exposure
Central control of exposure.
Distinguish between transaction/translation exposure
and economic exposure.
Forecast future exchange rate movements.
Good reporting systems to monitor firms exposure toexchange rate changes.
Produce monthly foreign exchange exposure reports.
-
8/8/2019 final exposure mgmt 1
7/30
7
Changes in exchange rates can effect firm value through:
Types of Foreign Exchange Exposure
-
8/8/2019 final exposure mgmt 1
8/30
Financial statements including information
of all subsidiaries and subsidiaries has to restate
the local currency transaction into home currencyand corresponding profit & losses arise due to
translation from local currency to home currency.
The accounting process of translation,involves converting these foreign subsidiaries
financial statements into home currency-
denominated statements.
Translation Exposure
-
8/8/2019 final exposure mgmt 1
9/30
Two basic methods for the translation offoreign subsidiary financial statements areemployed worldwide
The current rate method
The temporal method
-
8/8/2019 final exposure mgmt 1
10/30
The current rate methodis the most prevalent in theworld today.
Assets and liabilities are translated at the current rate of
exchange. (for eg: cash & current liabilities)
Income statement items are translated at the exchange rate on
the dates they were recorded or an appropriately weighted
average rate for the period.
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 (CTA).
Current Rate Method
-
8/8/2019 final exposure mgmt 1
11/30
Current Non current Method
Under this method a foreign subsidiaries currentassets and current liabilities are translated atcurrent exchange rate to home currency.
Non current assets and liabilities are translated athistorical exchange rate, i.e. the rate prevailing atthe time of creating current assets and liabilities.
-
8/8/2019 final exposure mgmt 1
12/30
TemporalMethod
In temporal method inventory can be translated at current
exchange rate if it is shown in the balance sheet at market
value. Otherwise like non monetary and monetary method
it will be translated into historical exchange rate.
This method assumes that a number of individual line item
assets such as inventory and net plant and equipment are
restated regularly to reflect market value.
Gains or losses resulting from remeasurement are carried
directly to current consolidated income, and not to equity
reserves (increased variability of consolidated earnings).
-
8/8/2019 final exposure mgmt 1
13/30
Monetary / Non-monetary
Assets & Liability
If these items were not restated but were instead carried athistorical cost, the temporal method becomes the monetary/non-monetarymethod of translation.
- Monetary assets and liabilities are translated at current exchange
rates. (eg: cash & current liabilities)
- Non-monetary assets and liabilities are translated at historical rates.(eg: Inventory, plant & equipment, long term debt)
- Income statement items are translated at the average exchange ratefor the period.
- Dividends (distributions) are translated at the exchange rate on thedate of payment.
- Equity items are translated at historical rates.
-
8/8/2019 final exposure mgmt 1
14/30
Transaction Exposure
when a company is involved In the international trade,there is risk of fluctuations in the foreign exchange
currency rate because of certain factors, which results in
loss or gain to the company.
-
8/8/2019 final exposure mgmt 1
15/30
Types Of Exposure
Export and Import on credit which will have
transaction exposure
Borrowing or lending of funds from foreign countries.
Acquiring Assets and incurring liabilities dominated in
foreign currency.
-
8/8/2019 final exposure mgmt 1
16/30
Exposure management--Hedging
Why Hedging?
Hedging is the taking of a position i.e. acquiring either a cash flow, an asset or contract
Which will rise or fall in value which will offset a fall or rise in the value of an existing
Position.
It protects from a potential loss.
It reduces variances of future cash flow.
Managing Transaction Exposure:
1. ForwardMarket Hedge:
A company that is long a foreign currency will sell the foreign currency forward
where as company that is short a foreign currency will buy the currency forward.In this way the company can fix the dollar value of future foreign currency cash
flow.
-
8/8/2019 final exposure mgmt 1
17/30
The borrowing and lending in multiple currencies,
(i.e. to eliminate currency risk by locking in the value of a foreign currency transaction
in one's own country's currency).
2.MoneyMarket Hedge
Example:
Dayton, a U.S.-based manufacturer of gas turbine equipment, has just
concluded negotiations for the sale of a turbine generator to a British firm
for the sum of 1,000,000. The sale is concluded in March but payment
will be made three months later, in June.
Assumptions
Spot exchange rate: $1.7640/.
Three-month forward rate: $1.7540/.
Daytons cost of capital: 12%.
U.K. three-month borrowing /lending rate: 10% /8% per annum.
U.S. three-month borrowing /lending)rate: 8% /6% per annum.
-
8/8/2019 final exposure mgmt 1
18/30
The forward contract is entered at the time the A/R is created, i.e. in March.
The sale is recorded at the spot rate, in this case $1.7640/.
IfDayton does not have an offsetting A/P of the same amount, then the firm is
considered uncovered.
Hedging in the forward market here means selling 1,000,000 forward at the 3-
month forward rate of $1.7540/.
In 3 months, Dayton will received 1,000,000 and exchange them at the rate
$1.7540/, receiving $1,754,000 with certainty.
The forward contract creates a foreign exchange loss of $10,000
(10,00,000(1.7640-1.7540)).
Forward Market Hedge
-
8/8/2019 final exposure mgmt 1
19/30
Transaction Exposure Example:MoneyMarket Hedge
To calculate how much to borrow, Dayton needs to discount the PV of the1,000,000,10,00,000/1.025= 9,75,610
What can Dayton do with the loan?It can exchange the 975,610 at the spot rate of $1.7640/, which gives$1,720,976,
and invest it in a US$-denominated asset.The loan proceeds can be:
Invested at the US rate of6.0% per annum;
Used instead of a loan that would have otherwise been taken for working capital
needs at the rate of 8.0% per annum
Invested in the firm itself, the cost of capital being 12.0% per
annum.
Payoff to each alternative:Alternative Value in 3 Months
T-bill $17,20,976*1.015 = $17,46,791
Working capital $1;720;9761.020 = $17,55,396
In the firm $17,20,976*1.030 = $17,72,605
-
8/8/2019 final exposure mgmt 1
20/30
Note that the forward hedge yields $1,754,000 in three months. The
money market hedge is superior to the forward hedge if the
proceeds are used to replace a dollar loan (8%) or conduct general
business operations (12%). If Dayton could only invest in T-bills(6%), the forward hedge would be preferable.
3 Risk Shifting
Attempt to invoice exports in strong currencies and imports inweak currencies
3 Risk Sharing
Currency risk sharing can be used by formulating a customized
hedging contract where by a base price is adjusted to reflectcertain exchange rate changes. The parties to contract would share
the currency risk beyond neutral zone. This neutral zone
represents the currency range in which risk is not shared.
-
8/8/2019 final exposure mgmt 1
21/30
EXPOSURE NETTING
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
-
8/8/2019 final exposure mgmt 1
22/30
TYPES OF NETTING
1) PAYMENT NETTING
2) OBLIGATION NETTING
3) CLOSE OUT NETTING
EACH OF THE ABOVE 3 TYPES OF NETTING CAN
BE CONDUCTED AS :
BILATERAL
MULTI LATERAL
-
8/8/2019 final exposure mgmt 1
23/30
-
8/8/2019 final exposure mgmt 1
24/30
-
8/8/2019 final exposure mgmt 1
25/30
-
8/8/2019 final exposure mgmt 1
26/30
-
8/8/2019 final exposure mgmt 1
27/30
ECONOMIC EXPOSURE
It may be defined as the extent to which or degree
to which the value of firm changes. Measured by
present value of future cash flows as a result ofexchange rate changes.
IT CAN BE EXPRESSED AS :
PV of CASH FLOW
EXCHANGE RATE
-
8/8/2019 final exposure mgmt 1
28/30
MANAGEMENT OF ECONOMIC
EXPOSURE
Managing economic exposure includes:
Marketing Strategy
1. Market Selection
2. Pricing strategy3. Promotion Strategy
4. Product Strategy
-
8/8/2019 final exposure mgmt 1
29/30
Production Strategy
Shifting Production among plants
Plant location
Raising Productivity
Financial Strategy
Generating liabilities in same currency in which assets
have been created
-
8/8/2019 final exposure mgmt 1
30/30
THANK YOU