INTL303chpt11 hedging
Download
Report
Transcript INTL303chpt11 hedging
Slide 1 of 52
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 2 of 52
Managing Transaction Exposure
Chapter 11
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 3 of 52
Overview
Identify
techniques for hedging
transaction exposure
Describe how each technique hedges
an MNC’s payables and receivables
Compare the different hedging
techniques
Observe other methods that reduce
exchange rate risk
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 4 of 52
Exchange Rate Exposure
There are 3 forms by which a MNC is
exposed to exchange rate fluctuations
1. Transaction exposure
2. Economic Exposure
3. Translation Exposure
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 5 of 52
Transaction Exposure
Exposure exists when future cash transactions
are affected by exchange rate fluctuations
Affects
future cash flows
– e.g., MNC from US has payables
denominated in German marks
1.
identify degree of exposure
2. decide whether to hedge and if so, then what
percent of payables to hedge
3. select the hedging technique
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 6 of 52
Before Hedging
Before
making any decisions about
hedging
you should identify the net transaction
exposure on a currency-by-currency
basis
Net means all inflows and outflows
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 7 of 52
Before Hedging
If
it turns out that the inflows and
outflows, across all the subsidiaries
offset each other, then you do not need
to hedge !!!
Problem is, individual managers do not
like to be exposed because they think it
looks bad on their record
Page 335
So they may hedge
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 8 of 52
Before Hedging
If
the individual managers hedge, they
might erode some of the offset
advantages that the whole firm has
It must be kept in mind that the goal of
the MNC is to be profitable as a whole not just each subsidiary
remember when hedging there are
transaction costs - its not free Page 335
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 9 of 52
Transaction Exposure
Identifying Net Transaction Exposure
Conduct
analysis by currency
– calculate the “net” exposure for each
currency
– make hedging decisions on MNC-wide basis
consolidates
all subsidiaries
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 10 of 52
Transaction Exposure
Hedging
within MNC and agency theory
– MNC should hedge at the corporate level
– subsidiary managers may try to protect
their own cash flows
redundant
hedging may occur within MNC
MNC X:
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 11 of 52
Transaction Exposure
Corporate
level hedging practices may:
– 1. create unhedged positions of subsidiary
– 2. may increase riskiness of subsidiary’s
cash flow
Subsidiary
hedging without MNC
approval:
– may leave MNC exposed
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 12 of 52
Text’s example of
Eastman Kodak Company’s
Example of Kodak’s centralized currency
management approach
Irrelevant
to us in Canada
we just don’t have that many companies
who are so large and have
manufacturing and business in so many
places that such questions of hedging
would be relevant
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 13 of 52
Is Hedging Worthwhile ?
“…
on the average it will not reduce the
MNCs costs … it could be argued that
hedging is not worthwhile…”
text page 336
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 14 of 52
Canadian companies that
might use hedging
Magna
BCE
/ Nortel
Noranda
Air Canada
Celestica
Xerox
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 15 of 52
Canadian companies that use
hedging
Bombardier
Alcan
Canadian Airlines
McCains
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 16 of 52
Top companies in Canada that
might need to do centralized
foreign currency management
…
from the class
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 17 of 52
Transaction Exposure
Approaches to Hedging
1)
Hedge only when currency expected
to move in direction that makes hedging
feasible eg. approach of Black & Decker
– if MNC expects the DM to depreciatePage
in 336
value
hedge
only inflow exposure (receivables)
– if MNC expects the DM to appreciate in
value
hedge
only outflow exposure (payables)
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 18 of 52
Transaction Exposure
Approaches to Hedging
2)
Hedge 100 percent of net exposures
in foreign currency (Seagram Company)
– eliminates uncertainty when valuing
expected cash flows
– - they don’t do it to make any money, but
rather to prevent losing a lot of money,
which then helps a lot with planning
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 19 of 52
“Most
MNCs do not perceive their
foreign exchange management as a
profit center”
that is they do not do hedging to make
money -they do it to
Page 337
1. Measure exposure in order to assess risk
2. Determine whether the exposure should be
hedged
3. Determine HOW the exposure should be
hedged
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 20 of 52
Adjusting the Invoice Policy to
Manage Exposure
Sometimes
a large company will have
to pay for things in “x” from “X” country
It might also sell stuff to “X” country
Page 337
denominated in dollars
One of the things you can do is
denominate it in “x” so you balance your
exposure
textbook example uses paying in Swiss francs
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 21 of 52
Transaction Exposure Hedging
Techniques
1)
Futures hedge
2) Forward hedge
3) Money market hedge
4) Currency option hedge
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 22 of 52
1. Futures Hedge (Currency Futures)
Characteristics
of contract
Page 338
– buyer of futures contracts
– depends if your purpose is payables or
receivables
entitled to receive a specified amount in a specified
currency for a stated price on a specified date
expects the currency to appreciate in value
if it appreciates, then they will have saved money because
in the future, they will not have had to pay at the higher
price
sometimes they can backfire
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 23 of 52
2. Forward Hedge (Forward Contract)
Page 339
Used
heavily by large corporations
– usually because they have to pay for a large
amount of material, supplies or component
parts
– “… contract specifies the exchange rate at
which currencies will be exchanges”
– if you don’t know the amount, then you have to
lock in the rate
– if you know the amount, then you could do a currency futures hedge
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 24 of 52
2. Forward Hedge
Hedging
vs not hedging on payables
– MNC compares possible outcomes
hedging
produces known results
not hedging permits range of possibilities to
exist
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 25 of 52
2. Forward Hedge
Hedging
vs not hedging on receivables
– MNC compares possible outcomes
hedging
produces known results
not hedging permits range of possibilities to exist
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 26 of 52
3. Money Market Hedge
Page 344
Hedge
on payables
basically, if you have the money
available, you can but it in the bank, in
the denomination of the currency you will
need, and the small amount of interest
you will earn might cover the possible
drop if you did not take this action
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 27 of 52
3. Money Market Hedge
Page 344
Hedge
on payables
If you take this action, it requires you do
2 things
1. Borrow funds in the particular currency
2. Make a short term investment in that
currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 28 of 52
3. Money Market Hedge on Receivables
Page 345
Hedging
on receivables
If you expect some large amount of
money coming in (say, $2M Pounds)
Maybe you expect the Pound to drop in
the next few weeks so that incoming
money will be less in value
What you can do is borrow the 2 million
pounds now
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 29 of 52
3. Money Market Hedge on Receivables
Page 345
Hedging
on receivables, continued,,,
Now, for a short period of time you will
have to pay interest in the 2 million
pounds, but when you payment comes
in from the person you are doing
business with, you can take that 2
million pounds, and use it to pay back
the other 2 million pounds you borrowed
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 30 of 52
3. Money Market Hedge on Receivables
Page 345
Hedging
on receivables, continued,,,
The reason you would want to do this is
just in case Pounds dropped very low,
the incoming Pounds may not mean
much in dollars, but they would still be
OK to pay off a short term loan
denominated in Pounds !
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 31 of 52
4. Currency Option Hedge
Unhedged
strategies
– may outperform hedging strategies
when
a payables currency depreciates
when a receivables currency appreciates
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 32 of 52
4. Currency Option Hedge
Page 346
Sometimes
using a Forward Hedge
(Forward Contract) and a Currency
Hedge (Currency Futures Contract) can
backfire,
therefore, people use currency options only problem is you have to pay a
premium for them, which sometimes
could negate any small advantages
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 33 of 52
4. Currency Option Hedge
Hedging
payables with call option
(buying)
– provides right to buy a specified amount of
a currency at a specific price with a
specified time period
– does not obligate the owner to buy the
currency
Page 346
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 34 of 52
4. Currency Option Hedge
Hedging
receivables with currency put
options
– provides right to sell a specified amount of
a currency at a specific price within a
specified time period
– does not obligate the owner to sell the
currency
Page 347
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 35 of 52
4. Currency Option Hedge
Hedging
receivables with currency put
options
– if the existing spot rate of the foreign
currency is above the exercise (strike)
price when the firm receives the foreign
currency, the firm can sell the currency
received at the spot rate and let the put
option expire
Page 347
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 36 of 52
Page 348
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 37 of 52
In the textbook, they spend some pages
explaining the different hedge techniques
on pages 349, 350 and 351, only to
conclude on page 352 that
Page 352
“… Fresno Corporation is likely to perform
best
if it remains unhedged…”
“…While the hedging techniques described in
this chapter can be useful, they have limited
effectiveness for the long term”
Page 355
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 39 of 52
Limitation of Repeated
Short-term Hedging
Long-term
hedging
– may be more effective than a series of
short-term hedges
when
a currency enters a long cycle of strength
or weakness
– e.g., Deutsche mark strengthened against
most currencies in the early 1990s
long
term hedges would have been more
effective
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 40 of 52
Long-term Transaction Exposure
Hedging
methods
– long-term forward contract
– currency swap
– parallel loan
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 41 of 52
Long-term Transaction Exposure:
Hedging
Long-term
forward contract
– time horizon up to five years
long-term
payables (outflow) exposure
long-term receivables (inflow) exposure
– commonly used for major currencies
– MNCs that benefit most from this hedging:
have
established fixed-price contracts
Page 357
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 42 of 52
Long-term Transaction Exposure:
Hedging
Page 357
Currency swap
works well for two companies that have
long term expectations of being exposed
to a currency, so they get their bankers to
“swap” the exposure for a better currency,
or their own
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 43 of 52
Long-term Transaction Exposure:
Hedging
Page 357
Currency swap
see handout given to class from WWW
http://www.finpipe.com/currswaps.htm
Currency swaps give companies extra
flexibility to exploit their comparative
advantage in their respective borrowing
markets
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 44 of 52
Long-term Transaction Exposure:
Hedging
Currency swap
from
Page 357
http://www.finpipe.com/currswaps.htm
Currency
swaps allow companies to
exploit advantages across a matrix of
currencies and maturities
Because of the exchange and re-exchange of notional
principal amounts, the currency swap generates a
larger credit exposure than the interest rate swap
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 45 of 52
Long-term Transaction Exposure:
Currency swap Hedging
from
Page 357
http://www.finpipe.com/currswaps.htm
Companies have to come up with the funds to deliver the
notional at the end of the contract. They are obliged to
exchange one currency's notional against the other
currency's notional at a fixed rate. The more actual market
rates have deviated from this contracted rate, the greater the
potential loss or gain. This potential exposure is magnified
with time. Volatility increases with time. The longer the
contract, the more room for the currency to move to one side
or other of the agreed upon contracted rate of principal
exchange. This explains why currency swaps tie up greater
credit lines than regular interest rate swaps.
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 46 of 52
Long-term Transaction Exposure:
Hedging
Example
of a swap serving two MNCs
– MNC A is a French firm
committed
to a four year contract in the US
expects to receive $6,000,000 at end of fourth year
– MNC B is a US firm with a contract in France
will
receive FF35,000,000 in four years
– MNCs A and B, with a bank’s help, arrange swap
permits
the exchange of $US for FF at an agreed price
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 47 of 52
Long-term Transaction Exposure:
Hedging
Parallel
loan
– a two-step currency exchange agreement
– two MNCs agree to:
1)
exchange FF for $US
2) re-exchange $US for FF at a specified
exchange rate and a specified time
– requires two currency swaps
at
inception of loan and at the second
exchange
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 48 of 52
Alternative Hedging Techniques
Three
common methods
– leading and lagging
– cross hedging
– currency diversification
Reduce
exposures formed from poor
forecasts
– standard hedging works best when MNCs
accurately forecast future exchange rates
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 49 of 52
Alternative Hedging Techniques
Leading
and lagging
– adjust the timing of payments or receipts
expects
currency change to affect receivables
or payables
– leading, moves up transaction
– lagging, postpones transaction
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 50 of 52
Alternative Hedging Techniques
Cross
hedging
– reduces transaction exposure in a currency
that cannot be hedged directly
– hedges with a currency that is highly
correlated with the desired currency
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 51 of 52
Alternative Hedging Techniques
Currency
diversification
– takes a portfolio approach to currencies
– MNC with transactions in many currencies
benefit most
Coca
Cola
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson
Slide 52 of 52
Summary
Techniques
to hedge transaction
exposures
– futures hedge
– forward hedge
– money market hedge
– currency option hedge
Alternative
methods
– used to hedge payables and receivables
exposures
Slides developed by Jeff Madura, with additions and enhancements by Tim Richardson