Transcript Document 7610546

1. What kind of risk？
Anything affecting demand and supply
Output prices
Input prices
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What kind of risk？
Foreign exchange
Historical NT$/US$ rate (1980-2001)
台幣美元匯率 (1980:11-2001:9)
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1.
What kind of risk？
Foreign exchange
Transaction risk （Current and future transactions）
• Sales is in US$, NT$ received will change when FX changes
• Elasticity is 1
– T＝eU，T is in NT$, U is in US$, e is FX rate
–ΔT/T=Δe/e
Economic risk
• When NT$ appreciates（from NT$42/US$1 to 38）, importers
will have a lower cost in NT$, domestic companies will lose
competitive advantages and profit will drop
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1.
What kind of risk？
Interest rates
Historical 31-90 days Commercial Paper rate
in Taiwan (1980:11-2001:9)
台灣31-90天商業本票年利率(1980:11-2001:9)
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2. Factors affecting the extent of
risk
Operating dimension
Products attributes
Production method（Operating leverage）
Financing method（Financial leverage）
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3.
How to deal with risk？
Take calculated risk
• Try to reduce the probability or the payoff of failure
• British Petroleum chooses not to insure externally against
losses above $10 million.
– Weak competition, high insurance permiums
– Low probability of loss
– Enough capital in the case of loss
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3.

How to deal with risk？
Reduce risk with operating decision
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Strategic move
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Know your markets
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Coca-Cola develop the franchise bottling system and reduce the
uncertainty from bottlers (Teisberg, 1993)
Microsoft develops browser and bundles with Windows95
J.P. Morgan's John Miller is strictly a numbers guy. Although he often goes
to the movies, he doesn't read scripts, doesn't care about plots, and doesn't
worry about which stars have signed on -- unless they threaten to bust the
budget. (Business Week, March 7, 2005)
He relies instead on a sophisticated financing model fueled by data on how
more than 300 films performed at the box office. It allows him to tune out
the noise and focus on what really counts in a movie's success.
What business plan: its budget size, financial partners, release date, genre,
distribution schedule, prospects in foreign, DVD, and other markets.
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3.
How to deal with risk？
 Reduce risk with operating decision
 Monitor
•
To combat Hollywood's spendthrift ways, Miller’s loan documents
are loaded with covenants, covering everything from limiting how
much of the bank's money a producer can spend on a single movie
to requiring his O.K. before producers add financial partners or
foreign distributors. Miller insists on quarterly reports to make sure
producers keep their promises, often sending in audit teams to
double-check. "He makes you work for your money," says Charlie
Lyons, CEO of Beacon Pictures, which has a $200 million credit
line with Morgan. "It imposes discipline on you."
 Choose appropriate production technology
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Choose capital intensive technology to reduce the impact of
exchange rate on labor cost
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3.
How to deal with risk？
Reduce risk with operating decision
Reduce risk over time
• To get more information
• Pursuing a project in stages, e.g., test market, to collect
more information or to wait for uncertainty to be resolved
• Staged financing in venture capital
Invest in flexibility
• For example, buy machines that can use different energies
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3.
How to deal with risk？
Reduce risk with operating decision
Diversification
• Do R&D in different technologies, e.g, GM in electric car
• Only large firms can afford to spread risk
• J.P. Morgan's John Miller issues loans for slates of films at a studio -5 to 15 at a time -- not single flicks. He figures 3 of 10 movies will
do well and one will hit the jackpot, offsetting losses from the flops.
"If you get up to 15 films, it's hard to lose money on a slate," says
Miller. (Business Week, March 7, 2005, Multibillion Dollar Baby)
Matching risk
• Matching the currency for revenue and cost
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3.
How to deal with risk？
Reduce risk with financial decision
Risk sharing with claim holders
Risk sharing with more people
• Syndicated loan
• Many shareholders
Risk sharing with input provider
• Builder and land owner
• Nissan and Yulon share FX risk
• A Brazilian mining company linked its price of electricity
to the price of their product
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3.
How to deal with risk？
Reduce risk with financial decision
Risk sharing with claim holders
Risk sharing with bondholders
• In mid 1980, Zambian cotton grower expanded its
operation using a loan whose interest rate is linked to
international price of cotton
• A West African gold mining company borrowed gold and
repaid with gold. Although it is denominated in gold, the
transaction actually took place in dollar equivalent
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3.
How to deal with risk？
Reduce risk with financial decision
Risk transfer
• Cost of risk transfer
• British Petroleum choose not to insure externally against
losses above $10 million
Insurance
• Used in event type of risk: Hurricane, earthquake
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3.
How to deal with risk？
Reduce risk with financial decision
Risk transfer
Financial products
• Used in continuous risk: price change
• Sometimes, it’s used together with a loan agreement
– In 1989, the first corporate loan after the Mexican default in
1982. It includes a fixed rate international loan, a copper
sales agreement, and a copper swap.
– Sales: A promise of future delivery (for the life of the loan) of
a fixed amount of copper at the future spot price. It ensures
the repayment of the loan.
– Swap: Converts the market price into a fixed price
– In 1990, the company entered another loan that includes a
secured loan and a hedging program (including a swap)
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How to deal with risk？
Reduce risk with financial decision
Matching risk
• Matching the duration of asset and liability
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4.
Hedging with financial instruments
Futures or Forwards
Contract
• Current FX rate is NT$35（Pc）, buyer will purchase
US$1 million with a FX rate PF after one month
• Currency 1972, interest rate 1975
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4.
Hedging with financial instruments
Futures or Forwards
Payoff at maturity for buyer
PF
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FX at maturity
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4.
Hedging with financial instruments
Futures or Forwards
Hedging with futures
• 1-to-1 hedging
• Minimum risk hedging：Number of futures used for each
spot position（HR）=-ΔPc/ΔPF
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4.
Hedging with financial instruments
Swap
Contract
• Currency 1982, interest rate 1982
• Current FX rate is NT$35（Pc）, buyer will purchase
US$1 million each year for the following 5 years, with a FX
rate PF
• Equivalent to 5 futures contracts
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4.
Hedging with financial instruments
Options
Contract
• Call
• Put
• Currency 1982, interest rate 1982
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Hedging objects
Asset or liability hedging
• Oil inventory hedging
• Foreign currencies accounts receivable hedging
Commitment hedging
• Contracts that had signed require the firm to pay foreign
currencies
Future transactions hedging
• Hedging or speculation?
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6.
Derivative usage in Taiwan
Source: Shu, Pei-Gi, and Hsuan-Chi Chen, 2003, The Determinants of Derivatives Use: Evidence from Non-Financial Firms in Taiwan,
Review of Pacific Basin Financial Markets and Policies 6:4
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6.
Derivatives usages
U.S. and Germany
• Survey in 1995 (U.S) and 1997 (Germany) (Bodnar and
Gebhardt, 1998)
• 78% of German firms using derivatives compared to 57%
of US firms.
• In both countries, foreign currency derivative usage is
most common, followed closely by interest rate derivatives,
with commodity derivatives a distant third.
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