final exposure mgmt 1

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EXPOSURE MANAGEMENT

GROUP NO: 8

MEMBER ROLL NO.

Mohit Jain 30

Priyanka Kabra 33 Ankit Shah 80

Chirag Shah 81

Dhaval Shah 82


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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


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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


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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 -


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STRATEGIES FOR REDUCING EXCHANGE

RISK

OPTIONS

FORWARD CONTRACTS

HEDGING


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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.


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Changes in exchange rates can effect firm value through:

Types of Foreign Exchange Exposure


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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


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Two basic methods for the translation offoreign subsidiary financial statements areemployed worldwide

The current rate method

The temporal method


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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


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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.


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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).


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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.


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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.


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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.


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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.


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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.


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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


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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


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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.


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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


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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


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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


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MANAGEMENT OF ECONOMIC

EXPOSURE

Managing economic exposure includes:

Marketing Strategy

1. Market Selection

2. Pricing strategy3. Promotion Strategy

4. Product Strategy


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Production Strategy

Shifting Production among plants

Plant location

Raising Productivity

Financial Strategy

Generating liabilities in same currency in which assets

have been created


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THANK YOU

Documents

final exposure mgmt 1