...leading manufacturer of durable equipment with sales in more than 50 countries. The analysis relies primarily on a three month field study in the treasury of HDG. Precise examination of factors affecting why and how the firm manages its foreign exchange exposure are explored through the use of internal firm documents, discussions with managers, and data on 3110 foreign-exchange derivative transactions over a three and a half year period. Results indicate that several commonly cited reasons for corporate hedging are probably not the primary motivation for why HDG undertakes a risk management program. Instead, informational asymmetries, facilitation of internal contracting, and competitive pricing concerns seem to motivate hedging. How HDG hedges depends on accounting treatment, derivative market liquidity, foreign exchange volatility, exposure volatility, technical factors, and recent hedging outcomes. * Department of Finance, Kenan-Flagler Business School, The University of North Carolina at Chapel Hill, CB 3490 – McColl Building, Chapel Hill, NC 27599-3490. Voice: (919) 962-9250, Fax: (919) 962-2068, Email: gregwbrown@unc.edu. A more recent version of this document may be available from my web page: http://itr.bschool.unc.edu/faculty/browngr. I gratefully acknowledge the assistance of the treasury staff of HDG in providing data and for allocating time to this endeavor. This study also benefited from the advice and comments of John Graham, David Haushalter, Jay Hartzell, John...
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...hypermarket to Europe in 1963. A hypermarket is a mega-store, similar to that of a Wal-Mart. They started in small French towns, but by 1969 expanded to Belgium. In 1975, they opened their first store outside of the European continent, they had expanded to South America’s largest country, Brazil. Carrefour’s strategy until 1998 was to grow organically. But since 1998, its growth has been fueled by acquisitions of other retailers. Carrefour’s Financing Policy Analysis The risk that a business' operations or an investment's value will be affected by changes in exchange rates. Carrefour is exposed to exchange rate risk because of foreign-currency exposure from imported goods. This risk was being hedged through forward contracts. The €13.5 billion of debt on the Carrefour books is 97% hedged in Euro currency. Carrefour has a large exposure risk to the Euro because of their hedging policy. Questions from the Book 1. What is going on at carrefour? • Carrefour is expanding through acquisitions o This will require taking on debt • Current capital structure o Long-term debt ▪ 97% of foreign exchange rate risk hedged in Euros 2 . why does the eurobond market exist? (or, is plentiful debt capital not available domestically?) • Why does this market exist o Market was fueled by growth of multi-national firms o Able to reach global pool of investors • Debt is available...
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...J. of Multi. Fin. Manag. 13 (2003) 123 Á/139 www.elsevier.com/locate/econbase Foreign-denominated debt and foreign currency derivatives: complements or substitutes in hedging foreign currency risk? William B. Elliott a,*, Stephen P. Huffman b, Stephen D. Makar b a Department of Finance, Oklahoma State University, 224 Business, Stillwater, OK 74078, USA b University of Wisconsin Oshkosh, Oshkosh, WI, USA Received 30 June 2001; accepted 20 April 2002 Abstract Using a unique dataset, this study examines the relationship between foreign-denominated debt (FDD), foreign currency exposure and foreign currency derivative (FCD) use, for a sample of US multinational corporations. We find a positive relationship between the exposure to foreign currency risk and the level of FDD, indicating that this debt may be used as a hedge. Moreover, FDD is negatively related to the use of FCD. We interpret this as further evidence that FDD is used as a hedge, and substitutes for the use of FCD in reducing currency risk. # 2002 Elsevier Science B.V. All rights reserved. Keywords: F23 Keywords: Hedging; Foreign debt; Currency derivatives 1. Introduction US multinational corporations (MNCs) employ a variety of financial and nonfinancial techniques to reduce or hedge their exposure to changing exchange rates (e.g. Bodnar et al., 1998; Marshall, 2000). Financial techniques include foreign- * Corresponding author. Tel.: '/1-405-744-8639; fax: '/1-405-744-5180 E-mail address: elliowb@okstate...
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...transaction exposure and operating exposure. Having determined whether the firm should hedge its exposure, this note will discuss the various things that a firm can do to reduce its economic exposure. Our discussion will consider two different approaches to handling these exposures: real operating hedges and financial hedges. Transaction Exposure Financial Techniques of Managing Transaction Exposure Transaction exposure hedging should have been discussed in some detail in the previous international finance course; however, we will briefly go over the standard financial methods available for hedging this exposure. The main distinction between transaction exposure and operating exposure is the ease with which one can identify the size of a transaction exposure. This, combined with the fact that it has a well-defined time interval associated with it makes it extremely suitable for hedging with financial instruments. Among the more standard methods for hedging transaction exposure are: i) Forward Contracts - When a firm has an agreement to pay (receive) a fixed amount of foreign currency at some date in the future, in most currencies it can obtain a contract today that specifies a price at which it can buy (sell) the foreign currency at the specified date in the future. This essentially converts the uncertain future home currency value of this liability (asset) into a certain home currency value to be received on the specified date, independent of the change in the exchange rate...
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...90-day forecasts of the percentage rate of depreciation of the dollar relative to the yen is 4%. a. Provide a qualitative description of Intel’s transaction exchange risk. Answer: Intel is a U.S. company, and it is scheduled to receive yen in the future. A weakening of the yen versus the dollar causes a given amount of yen to convert to fewer dollars in the future. This loss of value could be severe if the yen depreciates by a significant amount. b. If Intel chooses not to hedge its transaction exchange risk, what is Intel’s expected dollar revenue? Answer: If Intel chooses not to hedge, the expected dollar revenue is the expected dollar value of the ¥100,000,000. The expected spot rate incorporates a 1% weakening of the dollar. This means that the expected yen price of the dollar is 1% less than the current spot rate of ¥103/$ or Et[S(t+90,¥/$)] = 0.99 [pic]¥103/$ = ¥101.97/$ Hence, Intel expects to receive ¥100,000,000 / ¥101.97/$ = $980,681 c. If Intel does not hedge, what is the range of possible dollar revenues that incorporates 95.45% of the possibilities? Answer: We are told that the standard deviation of the rate of depreciation of the dollar is 4%. The standard deviation of the future spot rate is therefore 4% of the current spot rate or 0.04 [pic]¥103/$ = ¥4.12/$. Thus, plus or minus 2 standard deviations around the conditional expected future spot rate is ¥101.97/$ + ¥8.24/$ = ¥110.21/$ ¥101.97/$ - ¥8.24/$ =...
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...To: | George Saoud | From: | Peter Zarin | CC: | Stephen Heath, George Saoud and Salesh Nischal | Date: | Xxxxx | Re: | Hedge Accounting – Designation and Effective Testing as at 30 June 2015 | Executive Summary In Q4 FY15, FHL Group decided to elect to adopt IFRS 9 Hedge Accounting which will enable the Group to more effectively mitigate the adverse foreign exchange movements involved with importing of raw materials and finished goods for our leading retail business units, c $120M per year. The identification of foreign exchange risk has been formally identified as a key financial risk to the Group and as such compliments this decision to adopt hedge accounting as a method by which to minimise the volatility of the AUD against the USD contracts. The risk likelihood and impact are considered high in both cases. FHL has chosen to hedge with Forwards Exchange Contracts to hedge the foreign exchange risk. A forward contract is a contract to exchange a fixed amount of f financial assets on a fixed future date at a fixed price. The fair value of a forward contract is affected by changes in the spot rate and changes in the forward points. Although the Group has used forward contracts in the past, the adoption of IFRS 9 Hedge Accounting has not been applied because the tenure of the contracts was hedging against AUD/USD FX rates three months out from the accounting period. The Board has decided that the tenure should now look prospectively 6 months out which brings...
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...Sandra Vargas Amulya Gattu, Hanny Gomez, Tamta Kavtaradze, Sandra Vargas Link Technologies Case Analysis Link Technologies Case Analysis Link Technologies Case Report The derivatives program was reducing risk when the firm was investing in foreign currency futures for the first four months from the implementation date (February 1991 to May 1991). This is seen by the negative correlation of (0.94226594) between the derivative (futures) cash flow and the unhedged cash flow. A purpose of a perfect hedge is to obtain a net of zero or in other words, reduce your risk to nothing not including the cost of the hedge. If a correlation is negative, as it was for the first three months, it means that investing in futures contracts was the right move because the cash flows are moving in opposite directions to minimize the risk. Another way to evaluate the performance of the hedging strategy is to compare the variance of unhedged cash flow and the hedged cash flow, expecting that that variance of the unhedged should be greater than the hedged cash flow. As seen in the table below, the variance of the unhedged is greater than the variance of the hedged when Link Technologies invested in currency futures contracts. Futures Variance | | Unhedged CF | 20,691,861,693.67 | Hedged CF | 2,774,199,924.92 | Difference | 17,917,661,768.75 | Even though, the hedging program was perfectly implemented, Mr. Lee strongly believed that...
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...sale. A follow-on order provides the context for exploring possible mechanisms for managing that risk. In particular, sufficient direction and information is provided to examine both a forward hedge and a money-market hedge. The learning objectives of the case are as follows: * To explore the magnitude and effect of exchange-rate risks. * To illustrate exchange-rate risk management through two conventional hedges—a forward-contract hedge and a money-market hedge. * To demonstrate market parity and identify how preferences arise from unique company characteristics. * To explore issues related to pricing of international bids. Suggested Questions 1. How profitable is the original sale to Novo once the exchange-rate changes are acknowledged? How might the exchange-rate risk, which affected the value of the order, have been managed? 2. Assuming Baker agrees to the new Novo sale, determine the present value of the expected future cash inflow assuming: (1) there is no hedge, (2) the company hedges using a forward contract, and (3) the company hedges using the money market. Finding a present value is necessary for the following reason: With no hedge or a with forward-contract hedge, the cash flow will occur at the time of payment by Novo. With the money-market hedge, Baker receives a cash flow...
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...Japanese yen, in 3 months u Borrow and pay now? u Use a forward contract/FX swap? u Pay later at spot? Copyright ©1997 Ian H. Giddy Forwards, Futures and Money-Market Hedging 8 Forward Contracts, Futures and Money Market Hedging Money market hedging: match currency of assets and liabilities l Forwards: OTC agreement to exchange currencies at certain exchange rate in the future l FX swap: simultaneous spot sale and forward purchase of a currency l Futures: Exchange-traded contracts for notional future delivery, minimizing default risk via marking-to-market l Copyright ©1997 Ian H. Giddy Forwards, Futures and Money-Market Hedging 9 Giddy Forwards, Futures and Money-Market Hedging/3 Forward Contracts Agreement to exchange currencies at certain exchange rate in the future l Default risk in forward contracts arises because such a contract is a commitment for future performance, and one or other party may be unwilling or unable to honor that commitment. l On the settlement date, one party in effect owes the other party a net amount. l Copyright ©1997 Ian H. Giddy Forwards, Futures and Money-Market Hedging 10 A Typical Forward Contract l We agree today to pay a certain price for a currency in the future Soles Backus Backus SANSANTANDER TANDER Copyright ©1997 Ian H. Giddy Forwards, Futures and...
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...Why should we hedge? Business is exposed to several risks, currency risk being one of them Objective of hedging is to ensure: Predictability in Income Statement thereby reducing cash flow volatility. Revenue is generated & receivables are collected at budgeted rates Maintaining margins on long term projects as these projects are priced & bid with an exchange rate assumption, which needs to be protected to ensure desired margins Managing the translation risks in case of multiple geographies & overseas entities Best Practices A good risk management and hedging policy should be debated, understood & approved at the highest level (Board) The policy should indentify risks entity is exposed to, ways to measure these risks & suggest methods to mitigate these risks Should specify clear identification of responsibilities, authorities & limitations on its implementation Should state the purpose of hedging clearly - profit, protection, reducing volatility. Should suggest appropriate risk management tools like Sensitivity Analysis, VAR to contain risks Should be reviewed periodically by board in view of changing risks, market dynamics. Enctheirage use of natural hedges to reduce hedging costs METHODS OF HEDGING Methods of hedging can be classified as a. Internal methods b. External methods ...
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...corporations to adjust to exposure to currency risk, interest rate risks, commodity price risks, and security holdings risk. Largely, companies are currently exposed to risks caused by unexpected movements in exchange rates and interest rates. Companies with a growing global presence are especially exposed to a wide range of financial risks, in particular foreign exchange risks and interest rate risk. Although, financial risks are the center of business operations of financial service firms, but they also impact the risk exposure of non-financial corporations. The management and supervision of these risks has become vital for the existence of companies in today’s unpredictable financial markets. The major financial risks that most firms are exposed to are interest rate risk, currency rate risk, commodity price risk, and security holdings risk. Interest rate risk is a very common type of risk, and result from a discrepancy in the sensitivity of a firms assets and liabilities to interest rate movements. On the other hand, currency risk exposure is virtually encountered by all firms, even if their exposure is not from a transaction or a translation risk. Many firms are also likely to face competitive risk due to foreign companies using weak home currencies to their advantage (Triantis). In 1944, the original global financial order was established and the Bretton Wood system was created. The system created an international basis for exchanging one currency for another and also led to the...
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...Foreign Exchange Derivatives Definition Any financial instrument that locks in a future foreign exchange rate. These can be used by currency or forex traders, as well as large multinational corporations. The latter often uses these products when they expect to receive large amounts of money in the future but want to hedge their exposureto currency exchange risk. Financial instruments that fall into this category include: currency options contracts, currency swaps, forward contracts and futures contracts. Types There are three types of foreign exchange derivatives used for hedging as follows: I. Forward Hedging II. Money Market Hedging III. Option Hedging Forward Hedging It refers to the Contract to buy or sell an asset at a given price on a specific date in the future. Investors use this device to avoid major losses if the price of the asset changes dramatically before it is exchanged. Money Market Hedging It refers to the Borrowing and lending in multiple currencies, for example to eliminate currency risk by locking in the value of a foreign currency transaction in one's own country's currency. Option Hedging It refers to the right to buy or sell foreign exchange at a specified strike price in exchange of a certain option premium either at the option expiration date or during the option period. * If one acquires the right to purchase foreign exchange, it is called the call option. Buyer of the call option pays option premium & it will be...
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...when a variety of currencies are involved. In the case of Nike’s proposal to expand in India, there are ways to migrate exchange rate risks by exposing the possible risks before they affect the company’s profit margin. One method is the transaction exposure. Transaction exposure is the degree to which the value of future cash transactions that are affected by exchange rate fluctuations. According to Madura, “Transaction exposure can have a substantial impact on a firm’s earnings. It is not unusual for a currency to change by as much as 10 percent in a given year. If an exporter denominates its exports in a foreign currency, a 10 percent decline in that currency will reduce the dollar value of its receivables by 10 percent. This effect could possibly eliminate any profits from exporting” (Thomson South-Western 2006). To assess transaction exposure, Nike will need to estimate its net cash flows in each currency and measure the potential impact of the currency exposure. According to Madura, “To measure its transaction exposure, an MNC needs to project the consolidated net amount in currency inflows or outflows for all its subsidiaries, categorized by currency….Estimating the consolidated net cash flows per currency is a useful first step when assessing an MNC’s exposure because it helps to determine the MNC’s overall position in each currency” (Thomson South-Western 2006). The standard deviation statistic measures the degree of movement for each currency. It helps to identify...
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...assignment, therefore, is to discuss and explain further the operations of MNCs and issues surrounding these corporations. Hedging Transaction Exposure Four of the Hedging Techniques Available To MNCs Hedging simply means minimizing or mitigating the effect of the exchange rate exposure. This risk is of three types namely, translation exposure, economic exposure and transaction exposure (Luo, 2001). A transaction exposure is a form of foreign exchange risk which results to loss or gains when operations are carried out or denominated in foreign currency (Hill, 2005). It is a short-term exposure that arises as a result of fluctuations in exchange rates. To mitigate or hedge the effects of this risk, an MNC can use any of the following four techniques. When selecting the method to apply, MNCs compare the expected cash flow from each one of these. A).Futures Hedge- to lock in the future exchange rate, a futures hedge uses currency futures. For smaller amounts of money, standardized futures...
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...1. What gives rise to the currency exposure at AIFS? American Institute for Foreign Study (AIFS) is a student exchange organization. It organizes exchange programs in education and culture throughout the world with two of its major divisions serving American students traveling abroad in the Study Abroad College division and High School Travel division. AIFS receives their revenues in American Dollars (USD) but incurs their costs and expenses in a foreign currency, mainly in the Euro (EUR) and the British Pound (GBP). AIFS’s currency is exposed to changes in the foreign exchange rate, therefore their gain or loss is determined by the appreciation or depreciation of the American dollar in the foreign market. In order for AIFS to protect its assets they need to hedge their currency in forward contracts and options to reduce currency exposure risks. There are three types of currency risks: the bottom-line risk, the volume risk and competitive pricing risk. AIFS starts to hedge foreign currencies between 6 months and 2 years prior to the main pricing date and the implement forward contracts and currency options (primarily forward contracts) to hedge currency exposure risks. AIFS establishes its pricing in advance and guarantees that price, so if the market changes they will still honor the set price. The Bottom-line Risk Adverse changes in exchange rates against the dollar without hedging could increase costs because AIFS requires large sums of money to cater to their clients...
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