...TABLE OF CONTENTS DECLARATION ii LIST OF ABBREVIATIONS iii CHAPTER ONE: INTRODUCTION 1 1.1 Background 1 1.1.1 Derivatives 2 1.1.2 Foreign Currency Exposure of a Commercial Bank 3 1.1.3 Effect of derivatives on foreign exchange exposure 5 1.1.4 Commercial Banks in Kenya 6 1.2 Research Problem 7 1.3 Objectives of the Study 8 1.4 Value of the Study 9 CHAPTER TWO: LITERATURE REVIEW 10 2.1 Introduction 10 2.2 Theoretical review 10 2.3 Foreign Exchange Risk Management 13 2.6 Empirical Review 18 2.6 Summary of Literature review 19 CHAPTER THREE: RESEARCH METHODOLOGY 20 3.1 Introduction 20 3.2 Research Design 20 3.3 Study Population 20 3.4 Data Collection Procedures 20 3.5 Data Analysis and Presentation 20 REFERENCES 22 APPENDICES 26 LIST OF ABBREVIATIONS CBK – Central Bank of Kenya ERV - Exchange rate volatility FOREX – Foreign Exchange FX – Foreign Exchange IFE – International Fisher Effect IFX - Income from foreign currencies as a percentage of total income IRP – Interest Rate Parity MST – Market Segmentation Theory NA - Net Assets NFXNA - Net Foreign Currency Exposure Relative to Net Assets NFX - Net Foreign Currency Exposure NSE – Nairobi Securities Exchange OS - Ownership Status or Nature of Ownership PPP – Purchasing Power Parity CHAPTER ONE: INTRODUCTION 1.1 Background The traditional role for commercial banks has been perceived...
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...Institute for Foreign Study (AIFS) is an organization, which helps enable American students to travel abroad. The main service AIFS provides entails organizing educational and cultural exchange problems across the globe. As the case explains, AIFS has split their business into two major divisions that that serve American student’s studying abroad; the Study Abroad College division and the High School Travel division. The college division, which is controlled by Christopher Archer-Lock, sends American students all over the world on semester-long exchange programs. The high school division, which was founded as the American Council for International Studies (ACIS), is controlled by Becky Tabaczynski and sends high school students and their teachers on 1-4 week long trips. This nature of business involves a certain amount of bottom-line risk. AIFS focuses largely on American students studying abroad, therefore the majority of their revenue is in American Dollars (USD). However, AIFS costs’ are generally incurred in foreign currency (primarily Euros (EUR) and British Pounds (GBP)) because the services they arrange for happen abroad. Due to their business activities involving foreign currencies, an unfavorable change in the exchange rate could result in a higher cost base, and potentially a loss overall if the change is significant enough. Inherently, due to the nature of their business, AIFS is exposed to currency risk because they are dealing in multiple currencies, however there is...
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...Case Study: Nodal Logistics and Custo Brasil Analysis of International Capital Investment Case Study: Nodal Logistics and Custo Brasil Analysis of International Capital Investment Table of Contents I. Introduction 2 II. Analysis of Different Hedging Methods 2 a. Forward Contracts 2 b. Currency Options 3 c. Currency Adjustment Clause 3 d. Local Currency Debt Financing 3 e. Cross-currency Swaps 3 f. No-hedging (“self insure”) 3 g. Extra: Cross-hedging 3 III. Decision 3 IV. References 4 V. Appendix 4 I. Introduction Nodal Logistics Corporation is an American-based Real Estate Investment Trust (REIT), working with warehouses and property acquisition for logistics purposes. Therefore, as a REIT, most of its revenues come from rents and leases. REITS also have a unique tax structure of their own: given that more than 75% of their profits arise from rents from real estate property, and they distribute at least 90% of their current period profits as dividends to their shareholders, they don’t pay corporate income taxes. Hence, as no tax benefits would arise using debt, they typically financed investments with all equity. All these characteristics of a REIT point to a very high profit rate of the business (large up-front capital investments with little actual ongoing operating expenses). However, it is important to bare in mind that a REIT might present some risks to the stakeholders, like investors, if it has vacant properties...
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...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. The main hedging technique...
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...Essay topic: why companies use currency derivatives? Currency derivative can be defined as a contract or financial agreement to exchange two currencies at a given rate or a contract whose value is derived from the rate of exchange of two currencies on spot (Shoup, 1998). Currency derivatives are developed and adopted to implement a strategy known as hedging, in which an organisation acquires a contract in order to offset an expected drop or rise in value of a position or future cash flow (Belk & Edelshain, 1997). This essay will outline the incentives and rationales behind an organisation that uses currency derivatives. There are three types of currency derivatives used in hedging, future contracts, forward contracts and options, although swaps are also commonly considered as a currency derivative (Shoup, 2008). These instruments are derived from a spot rate, which is the price of the “underlying currency” (Eiteman, Stonehill & Moffett, 2009). Options are normally more costly than future contracts and forward contracts, because options are rights rather than obligations to buy or sell a currency (gives buyers the right not to exercise the contract if the spot rate movement is not favourable) (Belk & Edelshain, 1997). Research in New Zealand indicates that 70% of currency derivative users used forwards, which are most prevalent currency derivative instrument (Chan, Gan & McGraw, 2003). This is possibly because forwards are easy to manage and understand and can be used in frequent...
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...Market with Hedging Instruments In partial fulfillment of the requirements of for award of Master of Management Studies Through Atharva Institute of Management Studies under the guidance of Prof. Aditi Mahajan Submitted by Paras Gada MMS Batch: 2010 – 2012. DECLARATION I, Mr. Paras Gada of Atharva Institute of Management Studies pursuing Masters of Management Studies hereby declares that I have completed this project on “Foreign Exchange Market with Hedging Instruments” for the Academic period 2010 – 12. The Project has not formed the basis for award of any other degree, associates, fellowship or any other similar titles. This information submitted is true and original to the best of my knowledge. Place: Mumbai Date: 3rd April, 2012 Signature of the Student ACKNOWLEDGEMENT The present work is an effort to throw some light on ‘Foreign Exchange market with Hedging Instrument’ the work would not have been possible to come to the present shape without the able guidance, supervision and help to me by number of people. With deep sense of gratitude I acknowledged the encouragement and guidance received by Prof Aditi Mahajan, for completion of my project report. CERTIFICATE This is to certify that Mr. Paras Gada, a student of Atharva Institute of Management Studies, of MMS SEM IV bearing Roll No. 12 and specializing in Finance has successfully completed the project titled “To study Foreign Exchange market with Hedging Instrument.” ...
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...PRACTICES - A STUDY IN INDIAN SCENARIO Sathya Swaroop Debasish Department of Business Management Fakir Mohan University Vyasa Vihar, Balasore - 756019 Orissa, INDIA ABSTRACT Indian economy in the post-liberalisation era has witnessed increasing awareness of the need for introduction of various risk management products to enable hedging against market risk in a cost effective way. This industry-wide, cross-sectional study concentrates on recent foreign exchange risk management practices and derivatives product usage by large non-banking Indian-based firms. The study is exploratory in nature and aims at an understanding the risk appetite and FERM (Foreign Exchange Risk Management) practices of Indian corporate enterprises. This study focusses on the activity of end-users of financial derivatives and is confined to 501 non-banking corporate enterprises. A combination of simple random and judgement sampling was used for selecting the corporate enterprises and the major statistical tools used were Correlation and Factor analysis. The study finds wide usage of derivative products for risk management and the prime reason of hedging is reduction in volatility of cash flows. VAR (Value-at-Risk) technique was found to be the preferred method of risk evaluation by maximum number of Indian corporate. Further, in terms of the external techniques for risk hedging, the preference is mostly in favour of forward contracts, followed by swaps and cross-currency options This...
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...Chapter One Introduction 1.1 INTRODUCTION Foreign exchange refers to the financial transaction where currency value of one country is traded into another country’s currency. The whole process gets done by a network of various financial institutions like banks, investors and governments. The exchange rate varies according to the value of each country’s currency which is based on the health of that particular country’s economy. Any individual or company engaged in overseas business should be aware of the risks of currency fluctuations. Customers without commercial contracts expressed in domestic currency (or fixed by an agreed rate of exchange) are fully exposed to what is known as an exchange risk. Exchange risk may arise because of exchange rate movements in the period from the original commercial contract, to the time of settlement of the domestic equivalent of the foreign currency amount. Foreign exchange risk management is designed to preserve the value of currency inflows, investments and loans, while enabling international businesses to compete abroad. Although it is impossible to eliminate all risks, negative exchange outcomes can be anticipated and managed effectively by individuals and corporate entities. Businesses do so by becoming familiar with the typical foreign exchange risks, demanding hard currency, diversifying properly and employing hedging strategies. No countries of the world can produce all their necessary commodities and services. So it has to buy the commodities...
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...MANAGING F OREIGN E XCHANGE R ISK WITH DERIVATIVES by Gregory W. Brown* The University of North Carolina at Chapel Hill May, 2000 Version 3.4 Abstract This study investigates the foreign exchange risk management program of HDG Inc. (pseudonym), an industry 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...
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...develop appropriate hedging strategies to protect them. Exchange rate risk is the unexpected exchange rate that may cause an organization to lose or gain income. Currency hedging is a method of minimizing the exchange financial rate risk within an international organization. Global Companies involved in operations should have good understanding of the financial risks that the company could go through prior to starting its venture. Exchange Rate Mechanisms Currency hedging is “a particular hedging strategy used to reduce risks in the foreign exchange market which are used as in any hedging situation, where one security would be offset by another security, such as holding a short and long position of the same security at the same time, (Investor Words, 2009).”This content can be found on the following page:http://www.investorwords.com/6779/ Is impossible to predict how much the currency will be worth on the exact day that company will be converting it. With hedging, the uncertainly is gone. When companies decide to expand their business into growing globally the company will have to deal with many new issues that would not have affected them if they would have continued doing business locally. The exchange rate is a very important factor when doing international business. This must be continually monitored. Any changes in the exchange rate can globally affect the company. A significant growth in number of banks as well as business websites that offer currency hedging, regardless of...
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...Study the Role of Hedging to Reduce Exchange Risks on Investments in Global Stock Market Executive Summary In this global business environment, organizations are engaged to perform business activities across the countries. In order to execute international activities, they are tended to receive and make payment in different currencies. Currency value of country tends to change due to several economic aspects such as government decisions, stability, GDP and BOP rate etc. Changes in such factors are tended to increase vulnerability of currency value that is responsible for creating exchange risk. Exchange of currencies among the business organizations and corresponding changes in their values creates variation in their positions of cash flow, balance sheet and future profitability. An adverse effect of firm’s profitability leads significant decrement in the value and performance of respective stock. Due to this, exchange risk is needed to be addressed with use of risk management strategy. The research is designed to Study the role of hedging to reduce exchange risks on investments in global stock market. Research objective will contribute to determine hedging strategy role in reducing exchange risk from stock market investment. By using inductive approach, interpretive philosophy, mixed design and non-probability sampling method, objectives of this research will be achieved by the researcher. Both primary and secondary data sources will be used to obtain information. An...
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...proposed investment decision of getting enlisted in foreign countries stock exchange market they choose to invest. Due diligence will enable the Company access all information relating to the movement of stock and share prices. This information will allow a company to avoid investing in equity markets that are highly volatile (Maskell & Baggaley, 2003. (Maskell & Baggaley, 2003), defines foreign-exchange risk fluctuations in the prices or value of an investment due to changes in foreign exchange rates or exchange rates. This risk is also known as exchange rate risk or merely currency risk; it is simply the loss an investor accrues during a long or a short position due to unfavourable movements in the exchange rates. Currency risk mostly affects international businesses that are more into imports and exports. The Case Study “Does the Devil Really Wear Prada?” In the case study, as presented by (Daniels, Radebaugh & Sullivan, 2015), I do not agree with this decision of Prada listing an IPO in the Hongkong Stock Market. I disagree because Prada might be adversely affected by the exchange-rate risk. Again their shares might be...
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...International Finance & Global Capital Markets Exposure Management Himanshu Bhutani A014| Dawood Bukhari A015 Shibani Gujrati A025| Siddhant Anthony Johannes A033 Nishtha Sardana A054| Prateek Walia A063 1 INDEX 1. Introduction…………………………………………………………………………………..3 2. Operational Exposure………………………………………………………………………..9 3. Transaction and Translation Exposure…………………………………………….……..11 4. Other Strategies used by Companies to Hedge Exposure……………………...………19 5. Case Studies: Hedging Strategy used by Companies………………………….………..20 2 INTRODUCTION Foreign exchange exposure represents a material risk for multinational corporations which are unrelated to business operations. One needs to identify each foreign exchange exposure, the risk it represents and methods and costs available to limit such exposure. The value of a firm’s assets, liabilities and operating income changes continuously due to change in factors such as exchange rates, interest rates, inflation etc. In other words, a firm is “exposed” to uncertain changes in a number of variables in its environment. Exposure may therefore be defined as a measure of sensitivity of the value of a financial item to changes in the macro economic variables mentioned above. Risk refers to the variability of the value of the item. FOREIGN EXCHANGE EXPOSURE Foreign Exchange Exposure occurs because of unanticipated change in the exchange rate. For example the difference in the spot rate & one month forward rate is 0...
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...Canadian mining- Impact of cost inflation and volatility and the road ahead Introduction With a 9.8% share of Canada’s GDP, the mining sector is critical to the future of the Canadian economy (Deloitte Report). Unfortunately, rising cost inflation, unprecedented volatility in commodity and energy prices and a strong Canadian dollar have negatively impacted the performance of this sector over the last year. This report seeks to uncover the drivers behind cost inflation and evaluate the hedging strategies utilized by Canadian companies to mitigate volatility through a case study of Barrick Gold. We will also examine the impact of tightening margins on the capital expenditure decisions of this company. Part 1: Cost Inflation Cost inflation in the mining industry has been driven by increases in both Operational expenses and Capital expenditures. Operational expenses have been driven by three factors 1) Wage Increases 2) Energy Costs and 3) Supply cost increases. Wages in this industry have increased dramatically over the past 10 years and the Canadian mining industry now boasts the highest wages of all industrial sectors in Canada. The average weekly pay for a mining worker in 2011 was $1,436, which surpassed the earnings of workers in forestry, manufacturing, finance and construction by 47%, 46%, 35% and 32% respectively (DELOITTE REPORT) Source: Mining Association of Canada – 2012 Facts & Figures Report http://www.mining.ca/www/media_lib/MAC_Documents/P...
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...Case Study on PepsiCo’s Use of Financial Derivatives 1. Introduction 1.1 PepsiCo’s History The Pepsi-Cola Company was incorporated in 1919 by Caleb Bradham, the inventor of the Pepsi-Cola soft drink. PepsiCo became a multinational beverage and snack food company in 1965 when Pepsi-Cola merged with Frito-Lay. Since the 1965 merger PepsiCo has expanded its operations by acquiring Quaker-Oats, Tropicana, and Gatorade brands. With sales of $66.86 billion in 2014 and with products sold in over 200 countries, PepsiCo is one of the leading food and beverage companies in the world (PepsiCo, 2014). 1.2 PepsiCo’s Industry The beverage and snack food industries are both in the mature stage in their life cycles, and companies in these industries largely depend on product innovation, brand recognition, and low prices to remain competitive. Like all companies PepsiCo faces risk of increases in operating expenses and decreases in net income due to market risk. Companies in PepsiCo’s industry have been forced to expand its product offerings into healthy foods and drinks due to an insurgent health and wellness in American culture. 1.3 PepsiCo’s Competitors PepsiCo’s top competitors consist of The Coca-Cola Company, Dr Pepper Snapple Group, and Nestle; additionally, because PepsiCo is a multinational company it must also compete with countless local snack and beverage companies across the globe. Coca-Cola has been viewed as PepsiCo’s main rival for around 100 years, and the competition...
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