...Introduction: Overview of the hedging techniques: In the financial market, almost all of companies need to face the currency risk. In order to manage the currency risk, companies will use different hedging techniques, such as financial and operational hedging techniques. For example, money market, futures contracts, options and forwards contracts are commonly used by firms, as well as operational hedging techniques. All of 4 types of financial hedging techniques are short-term hedge. Money market is a part of financial markets for assets involved in short-term borrowing,lending, buying and selling. Its features are high liquidity, lower risk, such as treasury bills. Futures contracts are future transaction for buying or selling, and made by Futures exchange. The date and place of the transaction have been provided. There are some features of futures contracts. Quantity, commodity and quality have been limited, excepting the price. Also, it cannot be done over-the-counter. Options is a financial tool, which based on futures. If purchaser hold the options, he/she will has a right, not the obligation, to buy from or sell to the seller of the provided commodity in the future as the same price as the price agreed now. The last financial hedging technique, forwards contracts, is a non-standardization contact between two parties to sell or buy in the future. Curb-exchange and cash transaction are the feathers of forward contact. This essay will focus on two operational hedging techniques...
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...Hard and Soft Currencies Renita McBath MGT/448 University of Phoenix December 1, 2011 Professor David Grier Global Financing and Exchange Rate Mechanisms of Hard and Soft Currencies Trading, bartering, buying, and selling are known as the act doing business. The action of doing business has been a way of life for human beings for Centuries. At some point in our history the difficulty of doing business equally became a challenge. For instance, one person would like to trade a jar of jelly to another person that owns cows. The trade is off balance because of the value of each item. The difficulty arose when trying to access a credit. At this point, currency was born. In the beginning, currency was established by villagers in the form of stones, paper, linen, and other countable items. Nowadays humans have evolved currency into unique metal and paper items that have unique values. Currently these uniquely valuable currencies are referred to as hard and soft. Further research will reveal an analysis of the use of the currencies in global financing operations as well as describing the importance of managing risks that may arise. Hard Currency Hard currency is a status associated with the material, paper, and coins that are circulated within a country and globally in an effort to buy and sell goods. Currently, hard currency is the most traded currency. Countries that acquire this currency status attain...
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... International Foreign Exchange Reserves Contents Introduction ......................................................... 11 PART ONE. Chapter 1. 1. 2. 3. 4. 5. THE THEORETICAL FOUNDATIONS Nature and Function .......................................... 19 Definition ............................................................. 19 Gold as a Foreign Reserve Assets ...................... 20 Reasons to Own and Use Foreign Reserves ...... 23 The Functions of Foreign Reserves ..................... 24 Exchange Rate Policy, Monetary Policy, and Foreign Reserves ......................................... 26 6. Foreign Reserve Adequacy ................................ 31 1. 2. 3. Financial Asset Risk and Return ........................ 36 Financial Assets .................................................. 36 Types of Asset Risk...
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...South-Eastern Europe Journal of Economics 2 (2006) 129-146 EXCHANGE RATE RISK MEASUREMENT AND MANAGEMENT: ISSUES AND APPROACHES FOR FIRMS MICHAEL G. PAPAIOANNOU, Ph.D. International Monetary Fund Abstract Measuring and managing exchange rate risk exposure is important for reducing a firm’s vulnerabilities from major exchange rate movements, which could adversely affect profit margins and the value of assets. This paper reviews the traditional types of exchange rate risk faced by firms, namely transaction, translation and economic risks, presents the VaR approach as the currently predominant method of measuring a firm’s exchange rate risk exposure, and examines the main advantages and disadvantages of various exchange rate risk management strategies, including tactical vs. strategical and passive vs. active hedging. In addition, it outlines a set of widely-accepted best practices in managing currency risk and presents some of the main hedging instruments in the OTC and exchange-traded markets. The paper also provides some data on the use of financial derivatives instruments, and hedging practices by US firms. JEL Classification: F31, G13, G15, G32, M21 Keywords: Financial Risk, Financial Management, Foreign Exchange Hedging, Corporate Hedging Practices Corresponding address: 700 19th Street, N.W. Washington, DC 20431 e-mail: mpapaioannou@imf.org This paper draws heavily on various presentations on risk management while the author was the Director of Foreign Exchange...
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...Gordon Bodnar Techniques for Managing Exchange Rate Exposure A firm's economic exposure to the exchange rate is the impact on net cash flow effects of a change in the exchange rate. It consists of the combination of 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...
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...Honeywell, Inc. and Integrated Risk Management Case Analysis Submitted to: Prof. A. Kanagaraj By Vivek Gupta Section C, 944 Executive Summary: Honeywell was a multibillion-dollar, International Corporation employing 53000 people and managing operations in 95 countries. It was the largest producer of control systems and products used to regulate heating and air conditioning in commercial buildings and of systems in avionics systems. Carrying out business in 95 countries firm faced a number of risks. Honeywell’s risk management activities were dispersed throughout the firm as shown in the table. Other risks were managed operationally. [pic] The committee voting for this new program depends on whether the anticipated savings of the program would be realized, and whether the coverage provided by the new contract would be adequate. The proposed plan is a first step in a firm wide integrated risk management program that would extend to cover all of Honeywell’s financial and operational risks, the finance committee’s decision would establish Honeywell’s risk management strategy for some years to come. Honeywell’s existing strategy was consistent with its risk management objective of minimizing earnings volatility and its cost of risk. The team wondered about the applicability of the relatively new concept of enterprise risk management, which is grouping many risks together into a portfolio of risks, rather than managing each risk separately. The team thought...
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...Managing Risk at Commercial Bank 1. Interest Rate Risk Interest Rate Risk (IRR) is the impact on interest income of the Bank due to possible changes in market interest rates as compared to current level. IRR constitutes the most significant component of market risk exposure of the Banking Book. Hence, the Bank monitors IRR on an ongoing basis giving due consideration to re-pricing characteristics of all assets and liabilities. Rate shocks of different magnitudes are applied to all assets and liabilities at regular intervals and the impact is monitored to ensure that the Bank’s earnings are within internally set parameters. Decisions to exceed such parameters taken at 2. Foreign Exchange Risk Foreign Exchange Risk is the possible impact on earnings and capital due to fluctuations in exchange rates. This may arise as a result of existing maturity mismatches of foreign currency positions. The Bank is exposed to foreign exchange risk, whenever it undertakes transactions in any currency other than Bank’s base currency, i.e. Sri Lankan Rupee (LKR). Risk tolerance limits for FX exposures set by the Bank, which are more stringent compared to the regulatory limits of Central Bank of Sri Lanka (CBSL) parameters, ensure that the Bank maintains the un-hedged FX positions at an acceptable level to prevent potential losses from adverse fluctuations in FX rates. The Bank is also exposed to FX Risk due to both FX...
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...in a currency union Advantages of the currency union: • It is a horizontal integration • Increased efficiency in resource allocation • Easy access to labor markets • Easy access to financial markets • Prospective higher income per capita • Prospective lower inflation rate • Prospective significant increase in trade • Elimination of foreign exchange fees for inter-regional transactions • Reduced accounting costs • Reduced time and costs for inter-regional cross-border payments • Economies of scale • Reduced possibility of speculators to affect prices • Enhanced use of money as unit of account and payment system • Confidence in predictability of rates • Liquidity • Network economies Disadvantages of the currency union: • Countries cannot unilaterally change the value of the currency they use • Each central bank lost the ability to take unilateral monetary measures, i.e. there is no lender-of-last-resort in case of a crisis, or control over inflation in a crisis • Spillover costs, where some countries can incur spillovers of imbalances from the other countries of the union; dangerous especially in difficult situations • The plans for economic convergence is actually not implemented yet • Fiscal discipline and monetary cooperation is not used by all members Planning the business: • The company needs to identify its strategic risk (product, production and transport, commercial, adverse business, political, currency) and create a strategy for managing it ...
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...nations has advanced in terms of products. Today, nations deal in trading countless types of products including electronics, liquor, and military equipment. One type of trading among nations is known as countertrade. Countertrade is an association between two parties in which goods and/or services are traded for goods and/or services as an alternative to money. These parties can be between companies as well as countries. For example, a large company in Europe can trade a local product as a form of payment to another company in the United States for a particular American product. If a nation’s currency is not exchangeable or no good overseas, they may offer a commodity or other product in place of cash (Gonzales, 2011). One of the most familiar events involving countertrade was between global soft drink giant, Pepsi and the former U.S.S.R. who had limited access to foreign currency due to its communist ideology. In 1972, Stolichnaya Vodka was used as payment to Pepsi by the Soviet nation for shipping syrup to the U.S.S.R. Pepsi became the first foreign product sold in the U.S.S.R. Because of this incident, Pepsi now has the marketing rights of all Stolichnaya Vodka in the United States (West, 1996). There are six major models of countertrade most commonly found in the form of barter, counterpurchase, offset, switch trading, compensation or buyback, and clearing account arrangements. Barter is one of the most common models of countertrade. Simply put, in a barter...
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...Measuring/Managing Translation and Transaction Exposure Chapter 10 Lecture Notes Measuring Translation and Transaction Exposure PART I. ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE: Accounting and Economic Risk I. ALTERNATIVE MEASURES A. TYPES 1. Accounting Exposure: arises when reporting and consolidating financial statements require conversion from subsidiary to parent currency. 2. Economic Exposure: arises because exchange rate changes alter the value of future revenues and costs. Accounting Exposure B. Accounting Exposure = Transaction risk + Translation risk [pic] ALTERNATIVE MEASURES OF FOREIGN EXCHANGE EXPOSURE C. Economic Exposure = Transaction Exposure +Operating Exposure Operating Exposure arises because exchange rate changes alter the value of future revenues and costs. PART II. ALTERNATIVE CURRENCY TRANSLATION METHODS (ACCY) I. FOUR METHODS OF TRANSLATION A. Current/Noncurrent Method 1. Current accounts use current exchange rate for conversion. 2. Income statement accounts use average exchange rate for the period. B. Monetary/Nonmonetary Method 1. Monetary accounts use current rate 2. Pertains to - Cash - Accounts receivable - Accounts payable - Long term debt 3. Nonmonetary accounts - Use historical rates - Pertains to: Inventory, Fixed assets, Long term investments 4. Income statement accounts - Use average...
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...Final Project Melissa M Bigler A) Give an example of how one might reduce your exposure to a risk that is systematic to the US economy? Minimizing risk while retaining upside potential is key for most investors , that is why a number of traders and investors are diversifying and hedging with currency, currencies benefit from some of the same things that may hurt stock indexes, bonds or commodities and can be a great way to diversify a portfolio. Investing in foreign currency is mutually beneficial. Investor are exposed to two types of risk: idiosyncratic risk and systemic risk. Idiosyncratic risk is the risk that an individual stock's price will fall, causing you to accumulate massive losses on that stock. Taking this risk out of your portfolio is easy, just diversify your account across a broad range of stocks or stock-based ETFs, in turn reducing your exposure to a particular stock. Though diversifying across a broad range of stocks only addresses idiosyncratic risk. You still have to face the systemic risk. That risk , is the risk based on the whole stock market failing, the way to fix this problem is to minimize your portfolios exposure to a bear market by the use of a forex account, using the forex account to trade from while simultaneously managing your stocks. http://www.investopedia.com. B) Why is corporate finance important to all managers and discuss their primary objective. Corporate finance is a type of finance dealing with monetary decisions...
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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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...vol. V, no. 2, 2008, pp. 81-91 FOREIGN EXCHANGE RISK MANAGEMENT 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...
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...company was exposed to several types of risk as it operated in a global territory. Previously, the company had a much compartmentalised approach to risk management, with individual departments managing individual risks pertaining to them. For instance, currency risks were hedged using futures contracts and under the supervision of the Financial Risk Management Unit while traditional (hazard) risks were insured by its treasury – Insurance Risk Management Unit. However, this individualistic approach did not serve the intent of the company well and hence in consultation with insurance specialists Marsh Inc., auditor Deloitte & Touché and insurance Underwriter AIG, a new cost efficient method for managing Honeywell’s risk was created. Thus, Integrated Risk Management Program was born that combined protection against Honeywell’s currency risk and other traditionally insurable risks. Decision to be made A decision has to be taken on the adoption of the new Enterprise Risk Management Program considering its cost implication and savings offered in perspective of adequate coverage of all risks. This decision could well lead on to establishing long term Risk policy for Honeywell as well as whether this integration approach would be suitable for Honeywell. This case identifies the benefits of integrating risks and shows how such an approach might be valuable. Honeywell has diverse variety and variant degree of risks. Given this, how should its risk be managed? Current Situation Honeywell’s...
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...they also have to wrestle with the capital structure and profit repatriation policies of their companies’ subsidiaries. Capital budgeting decisions and valuation must reflect not only divisional differences but also the complications introduced by currency, tax, and country risks. Incentive systems need to measure and reward managers operating in various economic and financial settings. The Globally Competent Finance Function The existence of what amounts to internal markets for capital gives global corporations a powerful mechanism for arbitrage across national financial markets. But in managing their internal markets to create a competitive advantage, finance executives must delicately balance the financial opportunities they offer with the strategic opportunities and challenges presented by operating in multiple institutional environments, each of which has it own legal regime and political risks. There is also a critical managerial component: What looks like savvy financial management can ruin individual and organizational motivation. As we’ll see in the following pages, some of the financial opportunities available to global firms are affected by institutional and managerial forces in three critical functions: financing, risk management, and capital budgeting. Financing in the Internal Capital Market Institutional differences across a company’s operations allow plenty of scope for creating value through wise financing decisions. Because interest is...
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