Chapter 2 Power Point Slides

8/14/2019 Chapter 2 Power Point Slides

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Gray, Salter & RadebaughChapter 2

GLOBAL ACCOUNTING AND CONTROL: AGLOBAL ACCOUNTING AND CONTROL: A

MANAGERIAL EMPHASISMANAGERIAL EMPHASIS

a Sidney J. GraySidney J. Gray, University of New South, University of New South

WalesWales

a Stephen B. SalterStephen B. Salter, University of Cincinnati, University of Cincinnati

a Lee H. RadebaughLee H. Radebaugh, Brigham Young, Brigham Young

UniversityUniversity

a Slides Prepared by: Jennifer Anne SalterSlides Prepared by: Jennifer Anne Salter


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INTRODUCTIONINTRODUCTION

a This chapter explains:This chapter explains:

terminology of foreign exchange;terminology of foreign exchange;

major foreign exchange products;major foreign exchange products;

major types of foreign exchange risks;major types of foreign exchange risks;

alternative approaches to foreign exchangealternative approaches to foreign exchange

risk management.risk management.


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FX RISKS & SOLUTIONS CONTDFX RISKS & SOLUTIONS CONTD- An Import for Cash Problem- An Import for Cash Problem

Firm Location Currency Amt

Suntech California,

USA

US$ $107

ChangiBoards

Singapore Sin. $ $170

McBoards Edinburgh,

UK

British 64


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FX RISKS & SOLUTIONS CONTDFX RISKS & SOLUTIONS CONTD

- An Import for Cash Problem- An Import for Cash Problem

a What do we do now?What do we do now? Calculate the price in a common currency (US$Calculate the price in a common currency (US$

would be logical since you are US based).would be logical since you are US based).a How do we do that?How do we do that?

Get the price in local currency (Get the price in local currency (LCPLCP) for each) for eachlocation from the table.location from the table.

Divide theDivide the LCPLCP by the LC/US$ exchange rate toby the LC/US$ exchange rate toget theget the US$US$ Price. See Table 2.1/2.2 orPrice. See Table 2.1/2.2 orhttp://www.http://www.bmobmo.com/economic/.com/economic/..
http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/


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Lets look at 2.1 FirstLets look at 2.1 First

a its a word fileits a word file


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FX RISKS & SOLUTIONS CONTDFX RISKS & SOLUTIONS CONTD

- An Import for Cash Problem- An Import for Cash Problem

Company Country LocalCurrency

Price

# ofForeign

CurrencyUnits per

US$

US$Price

Suntech USA $105 1 $105

Changi

Boards

Singapore Sin$170 1.6783 $101.29

McBoards U.K. 64 0.6054 $105.71


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Lets change the number toLets change the number to

Today's rates fromToday's rates from BMOBMO

US $

Price

A/BSuntec

h

USA $105 1.0000 $105.00

Changi

Boards

Sing

apo

re

SGD 170.00 $0.55 $92.65

Mcboar

ds

Briti

sh

Pou

nds

64.00 $1.41 $90.39

Compa

ny

Cou

ntry

Local

Currency

price (A)

Number of Units

Per $Foreign

Currency (B)
http://www.bmo.com/economic/regular/fxrates.htmlhttp://www.bmo.com/economic/regular/fxrates.htmlhttp://www.bmo.com/economic/regular/fxrates.html


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FOREIGN EXCHANGE RISKS ANDFOREIGN EXCHANGE RISKS AND

SOLUTIONS -SOLUTIONS - Import for CreditImport for Credit

a What if you want to buy on credit?What if you want to buy on credit?

a Is Singapore still the cheapest supplier?Is Singapore still the cheapest supplier?

a Will the exchange rate stay the same?Will the exchange rate stay the same?

a Can you protect yourself from fluctuationsCan you protect yourself from fluctuations

in the exchange rate?in the exchange rate?


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SOLUTIONS -SOLUTIONS - Import for Credit ProblemImport for Credit Problem

a McBoards offers 6McBoards offers 6

mos. interest freemos. interest free

credit.credit.a For the others youFor the others you

must borrow at 1% permust borrow at 1% per

month.month.

a However, the BritishHowever, the British

Pound is a floatingPound is a floating

currency.currency.

DATE

GBP/

US$

Jan-99 $0.61

Feb-99 $0.61Mar-99 $0.62 Apr-99 $0.62May-99 $0.62

Jun-99 $0.63Jul-99 $0.63

Aug-99 $0.62Sep-99 $0.62


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The British Pound FloatsThe British Pound Floats

1.5

1.55

1.6

1.65

1.7

Jan-

99

Feb-

99

Mar-

99

Apr-

99

May-

99

Jun-

99

Jul-

99

A

ug-

99

Sep-

99

Month

US$/G

Number of $ per GBP


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SOLUTIONS -SOLUTIONS - Import for Credit ProblemImport for Credit Problem

a You can neutralize theYou can neutralize the

risk of the British risk of the British

changing in value bychanging in value byusing a derivative.using a derivative.

a FX Derivatives canFX Derivatives can

include forwardinclude forward

contracts, futures,contracts, futures,swaps and options.swaps and options.


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Derivatives - Forward ContractsDerivatives - Forward Contracts

a AAForward ContractForward Contract is a contract between ais a contract between a

foreign currency trader and a client for theforeign currency trader and a client for the

future sale or purchase of foreign currencyfuture sale or purchase of foreign currencyat a forward rate.at a forward rate.

a TheThe Forward RateForward Rate is a contractual rateis a contractual rate

between the FX trader/client for thebetween the FX trader/client for theamount of currency A needed to acquireamount of currency A needed to acquire

one unit of currency B at a fixed futureone unit of currency B at a fixed future

date. (Tbl 2.1)date. (Tbl 2.1)


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Extract from Table 2.1Extract from Table 2.1

a British Pound Per DollarBritish Pound Per Dollar

a SpotSpot .6054.6054

a One Month ForwardOne Month Forward .6054.6054

a Three Months ForwardThree Months Forward .6051.6051

a

Six Months ForwardSix Months Forward .6053.6053


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a Table 2.3 shows the impact of applying theTable 2.3 shows the impact of applying the

information on forward and interest ratesinformation on forward and interest rates

to the purchase of boards.to the purchase of boards.a The Singapore $ rate assumes that youThe Singapore $ rate assumes that you

have to pay cash spot for the purchasehave to pay cash spot for the purchase

from Singapore.from Singapore.


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Co. LCP(A)

LCUnitsPer $(B)

US $PriceA/B

Cost of100 units

Interest for6 months

TotalCost

Suntech $105 1.00 105.00 $10,500 $630 $11,130ChangiBoards

170 1.68 101.29 $10,129 $607.7 $10,736

McBoards 64 0.61 105.73 $10,573 $0 $10,573


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a From the pervious table we can conclude:From the pervious table we can conclude: McBoards initial US$ price is higher than otherMcBoards initial US$ price is higher than other

suppliers;suppliers; A deferred payment option with a forwardA deferred payment option with a forward

contract makes the British product a great dealcontract makes the British product a great dealmore attractive.more attractive. Lets redo this for todays rateLets redo this for todays rate

inin $/FC$/FCa Now lets talk about other methods ofNow lets talk about other methods of

containing FX risks.containing FX risks.
http://www.bmo.com/economic/regular/fxrates.htmlhttp://www.bmo.com/economic/regular/fxrates.htmlhttp://www.bmo.com/economic/regular/fxrates.html


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At Today's RatesAt Today's Rates

Co. LCP (A) LC Units

Per $ (B)

US $ Price

A*B

Cost of

100 units

Interest for

6 months

Total Cost

Suntech $105 1 105 $10,500 $630 $11,130

Changi

Boards

SGD 170 0.545 92.65 $10,129 $607.70 $10,736

McBoards 64 1.4018 89.7152 $10,573 $0 $10,573


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Derivatives - Futures, Swaps andDerivatives - Futures, Swaps and

OptionsOptions

a AAFutureFuture is a highly standardized foreignis a highly standardized foreign

exchange contract written against theexchange contract written against the

exchange clearing house for a fixedexchange clearing house for a fixednumber of foreign currency units and fornumber of foreign currency units and for

delivery on a fixed day.delivery on a fixed day.

a AASwapSwap is a simultaneous spot and forwardis a simultaneous spot and forwardtransaction.transaction.


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Options ContinuedOptions Continued

a AnAn OptionOption is the right to trade foreignis the right to trade foreign

currency at a given exchange rate on orcurrency at a given exchange rate on or

before a given date in the future.before a given date in the future.a There are two types of options:There are two types of options:

American Options - exercised during aAmerican Options - exercised during a

stipulated period.stipulated period. European Options - exercised at a specifiedEuropean Options - exercised at a specified

end date.end date.


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Options ContinuedOptions Continued

a OptionsOptions have the following terms:have the following terms:

An up front fee for the right to buy or sell a fixedAn up front fee for the right to buy or sell a fixed

amount of foreign currency.amount of foreign currency. This is given in US cents per foreign currencyThis is given in US cents per foreign currency

unit.unit.

This is in addition to the actual cost of theThis is in addition to the actual cost of theforeign currency.foreign currency.

Tables 2.4-2.6 in your text contain an exampleTables 2.4-2.6 in your text contain an example


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Major World Currency MarketsMajor World Currency Markets

a Markets cover almost 24 hours, starting withMarkets cover almost 24 hours, starting with

Auckland which is 14-16 hours ahead of Ohio, ie., ifAuckland which is 14-16 hours ahead of Ohio, ie., if

its 4pm in Cincinnati, its 11am the next day inits 4pm in Cincinnati, its 11am the next day inAuckland.Auckland.

a Tokyo: Cincinnati + 13 hours. About 15% of totalTokyo: Cincinnati + 13 hours. About 15% of total

volumevolume

a Hong Kong & Singapore: Cincinnati + 11 and 12Hong Kong & Singapore: Cincinnati + 11 and 12

hours respectively. Together roughly equal tohours respectively. Together roughly equal to

Tokyo in volume.Tokyo in volume.


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Continued:Continued:

a European Markets: London is the largestEuropean Markets: London is the largestmarket. Cincinnati + 5 hours. About 25% ofmarket. Cincinnati + 5 hours. About 25% of

total world market volumetotal world market volumea Other markets include Frankfurt and ZurichOther markets include Frankfurt and Zuricha North American Markets: New York is theNorth American Markets: New York is the

second largest market. Other marketssecond largest market. Other marketsinclude Chicago, San Francisco andinclude Chicago, San Francisco andToronto.Toronto.


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Continued:Continued:

a NOTE: Over 90% of all transactions includeNOTE: Over 90% of all transactions include

the US$ as one part, e.g., DM/$, etc.the US$ as one part, e.g., DM/$, etc.


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-- Selling at a Premium orSelling at a Premium or

DiscountDiscount

a Appli es to For war ds /Future sppli es to For war ds /Future sa PREMIUMREMIUM -- IF th e q u ota ti o n o f th e c urr enc yF th e q u ota ti o n o f th e c urr enc y

in the denomi na torn the denomi na tor ,, e. g., i n a $/ i s. g., i n a $/ i sgr ea ter f or del i ve ry i n th e f utu r er ea ter f or del i ve ry i n th e f utu r e(fo rw ar d) tha n f or del ive ry n ow (s pot),fo rw ar d) tha n f or del ive ry n ow (s pot),th at c urr enc y i s a t Ah a t c urr enc y i s a t A


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Premium or DiscountPremium or Discount

a PREMIU MREMIU M . IF THE SPOT FOR IS $1.5IF THE SPOT FOR IS $1.5PER AND THE FORWARD QUOTE IS $PER AND THE FORWARD QUOTE IS $

1.60 PER 1.60 PER ..

a Note : In the example $ AT A DISCOUNTNote : In the example $ AT A DISCOUNT ..


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OPTIONS:OPTIONS: COMPUTING THE COSTCOMPUTING THE COSTAND BENEFIT OF AN OPTIONAND BENEFIT OF AN OPTION

aThis exercise first calculates theThis exercise first calculates the

cost of an option and then itscost of an option and then its

potential benefit.potential benefit.aThe example is for 30-day optionThe example is for 30-day option

to buy Japanese Yento buy Japanese Yenusing USusing US

Dollars.Dollars.a 30 days will take us to July.30 days will take us to July.


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Computing Option CostComputing Option Cost

aThe rate we want to buy theThe rate we want to buy the

Yen at is $.00775 per .Yen at is $.00775 per .

aThe premium charged toThe premium charged to

execute such a contract is 1.64execute such a contract is 1.64

hundredths of a cent per hundredths of a cent per covered (dollars .000164 percovered (dollars .000164 per

).).


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Computing AN OptionComputing AN Option

a Contracts come in blocks of 6,250,000.Contracts come in blocks of 6,250,000.The cost of a contract is as follows:The cost of a contract is as follows:

a Premium at .000164$/ *6,250,000Premium at .000164$/ *6,250,000$1,025$1,025

a Brokerage Cost (admin. fee)Brokerage Cost (admin. fee) $$2525

aTotal Cost per ContractTotal Cost per Contract

$1,050$1,050


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A TYPICAL OPTION SCENARIOA TYPICAL OPTION SCENARIO

a Covering one hundred millionCovering one hundred million

(100mm).(100mm).

a How many contracts do weHow many contracts do we

need?need?

100 mm100 mm 6.25mm = 166.25mm = 16

Cost of cover: 16 x $1,050 =Cost of cover: 16 x $1,050 =

$16,800$16,800


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Option Scenario : CostsOption Scenario : Costs

a Potential benefit: If the valuePotential benefit: If the value

of the exceeds $0.00775 perof the exceeds $0.00775 per

plus the transaction cost, we plus the transaction cost, we

can exercise the option andcan exercise the option and

sell the for a profit.sell the for a profit.


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Option Scenario : CostsOption Scenario : Costs

Buy 100mm at $.00775/Buy 100mm at $.00775/

$775,000$775,000

Option Cost 16 contractsOption Cost 16 contracts$16,800$16,800

Additional admin. feesAdditional admin. feeson exercisingon exercising $400$400

TotalTotal $792,200$792,200


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Option Scenario : BenefitsOption Scenario : Benefits

a If we sell the at .0080 $/, weIf we sell the at .0080 $/, we

have a profit of $7,800.have a profit of $7,800.

a At .0090 $/, the profit isAt .0090 $/, the profit is

$107,800.$107,800.


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Classifying Risk and ExposureClassifying Risk and Exposure

a There are 3 types of foreign exchangeThere are 3 types of foreign exchange

exposure:exposure:

TransactionTransaction

TranslationTranslation

EconomicEconomic

Cl if i Ri k d E


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Classifying Risk and Exposure -Classifying Risk and Exposure -

Transaction ExposureTransaction Exposure

a Transaction Exposure arises because weTransaction Exposure arises because we

do not have a method of accounting fordo not have a method of accounting for

multiple currenciesmultiple currencies

a Examples of Transaction Exposure includeExamples of Transaction Exposure include

purchasing or selling on credit, goods orpurchasing or selling on credit, goods orservices where the price is stated in aservices where the price is stated in a

foreign currency.foreign currency.

CCl if i Ri k d E


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Transaction ExposureTransaction Exposure

a How do we handle inherent risks?How do we handle inherent risks?

Prepare a separate budget for internationalPrepare a separate budget for international

cash flows.cash flows. This will allow you to assess if the volume ofThis will allow you to assess if the volume of

unhedged cash flows is significant.unhedged cash flows is significant.

Cl if i Ri k d ECl if i Ri k d E


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Translation ExposureTranslation Exposure

a Translation Exposure is when assets andTranslation Exposure is when assets and

liabilities on a balance sheet in oneliabilities on a balance sheet in one

currency, have to be re-expressed incurrency, have to be re-expressed inanother currency .another currency .

a Accounting for this has caused discordAccounting for this has caused discord

between financial regulators and thebetween financial regulators and thebusiness community.business community.



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Economic ExposureEconomic Exposure

a Economic Exposure involves uncontractedEconomic Exposure involves uncontracted

and unplanned changes in future cashand unplanned changes in future cash

flows which are the result of changes inflows which are the result of changes inexchange rates.exchange rates.



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Economic Exposure ContdEconomic Exposure Contd

a Any decisions based on economicAny decisions based on economic

exposure are primarily long term.exposure are primarily long term.

a These decisions include choosing marketThese decisions include choosing marketand production facility locations.and production facility locations.

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Chapter 2 Power Point Slides