1、1,Transaction Exposure(or chapter 8),2,Agenda,Types of forex exposures?Causes of transaction exposure?Pros & cons of hedging transaction exposure?How to manage transaction exposure? Forward Market Hedge Money Market Hedge Option Market Hedge Institutional practices of forex risk management.,3,Types
2、of forex exposure,Forex exposure potential change in profitability, net cash flow, market value due to change in forex rate. Transaction Exposure changes in value of outstanding financial obligations incurred prior to change in forex, not due to settle until after forex change. Operating (Economic)
3、Exposure change in firm PV resulting from change in expected future operating cash flows due to unexpected forex change Translation (Accounting) Exposureaccounting-derived changes in owner equity due to consolidation in single currency. Tax Exposure varies by country, general rule only realized fore
4、ign losses are deductible for calculating income taxes,4,Why Hedge? Pros & Cons,Improves planning. Reduces likelihood of bankruptcy. Management better knows actual risks. vs. Currency risk management costly, may not increase expected cash flows. Shareholders more capable diversifying risk. Investors
5、 already factored forex exposure into valuation. Conducts hedging to benefit management. Managers cannot outguess efficient market . Management criticized for forex losses but not for cost in avoiding forex losses.,5,Expected Cash Flow,Net Cash Flow (NCF),NCF,Reduction of risk? Increase/decrease in
6、expected cash flow? Increase in value?,Why Hedge?,6,What causes transaction exposure?,Purchasing or selling on credit.Borrowing or lending in foreign currency.Being party to unperformed forward contract.Acquiring assets/ incurring liabilities in foreign currency.,7,Open Account Purchasing/ Selling,A
7、nticipa-tion Exposure,8,Borrowing &Lending,Grupo Embotellador de Mexico (Gemex)Dollar debt mid-December, 1994: $ 264 m PS 3.45/$ = PS 910,800,000. Dollar debt in mid-January, 1995: $ 264 m PS 5.50/$ = PS 1,452,000,000 (59% up!),9,How to manage transaction exposure?,Contractual hedge Operating hedges
8、 Risk-sharing agreements. Leads and lags in payment terms. Swaps. Natural hedge Financial hedge offsetting debt obligation. financial derivative such as swap.,10,Hedging Account Receivable,Suppose October sale for 1,000,000, A/R January. Spot $1.764/ 3m-forward $1.754/ (2.27% discount) Cost of capit
9、al 12.0% annual British 3m borrowing rate 10% annual British 3m lending rate 8% annual US 3m borrowing rate is 8% annual US 3m lending rate is 6% annual Jan. put on 1,000,000 w/ strike $1.75/; 1.5% premium. Forecasts 3m future spot $1.76/. Budget rate (lowest acceptable amount) $1.70/,11,Hedging Acc
10、ount Receivable,Unhedged position: 1,000,000 x $1.76/ = $1.76 m. Forward hedge: Forward contract & source of funds to fulfill the contract. Forward entered time A/R created (October). A/R recorded spot $1.764/, so $1,764,000. Covered (perfect) vs. uncovered (open) forward hedge. Money market hedge:
11、creates liability offset w/ asset in : balance sheet hedge. borrow PV of 1,000,000: 1,000,000/1.025 = 975,610. exchange 975,610 at spot $1.764/ for $1,720,976.,$1,720,976 Treasury bill 6% annual or 1.5%/qtr $1,746,791,$1,720,976 Debt cost 8% annual or 2.0%/qtr $1,755,396,$1,720,976 Cost of capital 1
12、2% annual or 3.0%/qtr $1,772,605,12,Option Market Hedge,Purchase put option. 3 month put option ATM strike $1.75/, premium 1.5%:Premium as of Jan $26,460 1.03 = $27,254. Unlimited upside, limited downside. Breakeven price, option hedge Upper bound: If pound appreciate above $1.754/ + $0.0273/ = $1.7
13、813/. Lower bound If pound depreciates below $1.75/ - $0.0273/ = $1.722/.,13,A / R Hedges,14,Account Payable Hedge,Assume 1,000,000 A/P in 90 days Unhedged position: expected pay $1,760,000. Forward market hedge: purchase forward $1.754/, cost locked $1,754,000. Money market hedge: Offset obligation
14、 by asset w/ matching maturity. Exchange US$ spot & invest for 90 days in .Carry the cost forward 90 days,15,Account Payable Hedge,Option hedge: purchase call option on payable. ATM call option w/ strike $1,75/ would be 1.5% premium. If spot less $1.75/ option expire & 1,000,000 purchased on spot ma
15、rket. If spot above $1.75/ option exercised: exchange 1,000,000 $1.75/ less option premium:Carried forward 90 days 12% p.a. premium $27,254.,Exercise call option (1,000,000 $1.75/ $1,750,000 Call premium (carried forward 90 days) $27,254 Total maximum expense of call option hedge $1,777,254,16,A / P
16、 Hedges,Call option: $1,777,254,17,Forex Risk Management for Real,Goals? cost center vs. profit center. Exposures? backlog exposure? selectively hedge backlog & anticipated exposures? Contractual Hedges? Amount of risk covered, proportional hedges? Currency options?,18,Things to remember,Types of forex exposures Transaction Operating Translation Tax How to hedge A/R & A/P transaction exposure? Money market? Forward market? Option market?,
