Upload
itreasurer
View
219
Download
0
Embed Size (px)
Citation preview
Continuing
Education
FX Management
Risk analys is
n FX Risk
ramework
Five considerations for judging your
com pan y s X Risk.
Whil
e most multin ational co mpanies
face fo eign exchange risks, few under
sta nd all the cons iderations that need
to
be we
igh
ed
in order to manage them
ef fectively. Th ese cons
id
er
at
io n s
includ
e: 1)
the mate
ri
ality of the risks
to the company's P&L; 2) the econom
ic nature of th e exposures; 3) opera
tional
co nsideration
s; (4)
compet
itor
considerations; and (5) the company's
primary business ob ject ives.
Materiality Th e materiality of th e
risks is clearly somethin g that mu st be
v iewed aga in st the forei gn currency
flows and in proportion to each indi
vidu al co
mp
a
ny
's P&L. For exa mple,
what is
th
e probability
of an exposure
caus ing financial distress?
Generall y speaki ng, t he greater the
size and
numb
er of material risks, the
Economic Nature
more atte n
tion should be paid , and
resour
ces
devoted, to managing them.
Converse l
y,
no time shou ld be wasted
on de minimis ri sks.
Economic
nature
Equall y
funda
mental, but less compa ny specific, is
the eco nomi c nature of a co mpany's
busine
ss
activ iti
es.
Periodi call y, trea
sury needs to take a step back and
view
their
FX management act iv it ies
in
this co nt ext. Some sa mp l e cate
gor ies are shown in the chart below.
A company 's economic nature rela
tive
to these categories may not be
static. Thus treas urers should reexam
ine their company's economi c nature
w henev er
it und ergoes sig ca n
transformat ions-e.g. major fo re ign
acqui sit ions or
asset
sa l
es.
Expansion may also cause compa
ni es
to
mov
e from hav ing
primarily
lo
ca
l operations to becoming comp lex
multinationa ls.
As compan ies beco me
more complex, the FX risk in the oper
ating margins their t reas
ur i es must
mi
t igate
becomes progressively
greater, requiring greater attention to
FX risk
management , polici es, and
co ntrols.
Operational considerations Whil
e
FX r isk ca n be ef f ic iently mitigated
w ith f in anc ial instruments, it is often
better to ex haust internal hedg
in g
mechanisms f irst. Th
ese
includ
e:
• netting of exposures within group
legal entities;
• cr
ea
tin g offsetting FX exposures in
different lega l entiti es via leading and
lagging, fore ign currency
funding
, and
cas h po sit ion to reduce ou tstanding
net exposures;
•
in t
egrat in g FX risk w ith business
co nsiderations for cur rency of billing
and currency of
payment decisions .
Competitor considerations It
is
not
alw ays the first reason to manage X
pos it ions, but cu rren
cy
manageme
nt
can be a so urce of competiti ve advan
tage. Better foreign excha n
ge
manag
me t similar to a low -cost producer
strategy- gives co
mp
ani es a greater
ab ilit
y to m a in ta in th e ir m ark
et
in g
st r
ateg
i es in t he face of adve rs e
exc hange rate moves.
The cur r
ency advantages/d isadvan
tages
are not always as they appear at
f irst g lance. Th e c lass ic examp le is
that of a sing le-co untry US exporter,
co
mp eting aga in st a Japanese single
co untry
exporter. At first glance, the
I
CU rrency o _ l p o s i t i
J
4
Category
\Loca l-in-local
oper·ations
Revenues Expenses
Loca l cu rrency Local currency
Single-country Mu lticurrency US dollars
globa l exporters
mpl e
multinationals
Complex
multinationals
US do llars M ult icurrency
Multicurrency M ult icurrency
Explanation
Se lf-conta ined loca l un its w ith
li tt le cross-border act iv ity
jExamples
//
M c
Don
ald's
Campbe
ll Soup
Doll ar costs represe nt efforts to M erck
develop and manufacture prod- Caterp il lar
ucts so ld wor ldw ide on a
non-
dollar bas is
Multicurrency costs
to extract
product worl
dw
ide so ld wo rld
w ide on a dollar-price basis, even
if denominated in local currency
Products sou rced and so ld on a
multicurrency bas is
Exxon
Alcoa
Johnso n & johnson
General Motors
;
_ _ _ . . _ _ J
Sour Gr nwich Treasury Advisors
Inte
rn
ational Treas urer/M arch 6, 1995
US exporter , op e rat in g
out of a
weaker do ll ar currency e
nvironm
ent
wo uld appear to have the currency
advantage.
Yet, it it is the japa nese exporter that
often had the adva
nt
age: With the
g1eater pu1·chas ing power
of
the Yen,
it
was able to purchase dollar-based
indust
rial commod iti
es
more cheaply
relative to i
ts US
comp
et
itor. Its lo
ca
l
costs relatively hi gher, the j apanese
co
mpa ny also was forced to become
a more effic ient
producer.
The
US
company on the other ha
nd
may have
been lulled into in ert ia, perhaps in
part by
it
s
see
ming
cu
rrency advan
tage._
Obv iousl y , t
hi
s is a simplif ied
exa
mpl e and analyz ing the competi
tive
imp
acts of currency positions is
mu ch more campi cated. Usu all y,
such analysis invo lves looking at the
sourcing and siting and other FX cost
structure specif ics fo r compone
nt
s or
products in a given industry and then
determining the component/product
mix of competitors .
Management s business objectives:
This is an important co nsiderat ion in
determining how a company wishes
to hedge. Most
publicly held
compa
nies in the US , for example, have the
primary
objective
of ma x imizing
reported ea rnings according to their
GAAP P&L. One r
es
ult
is
a tendency
to determine hedging strategies and
in strum ents on t he bas is of their
account ing
treatment.
Accounting tre tment aod obje.c- _
tive co nsiderations can also
come
into play w ith competitor co nsidera
tions. Compan ies w ith similar eco
nomic exposures
m y
have different
business ob j ec tiv es;
fo
r exa mpl e,
1
on e may be managing for long-term ,
growth w hil e another's goal may be
improv ing short-term ea
rnin gs per
share. •
This framework
ha
s been adapted from
one used by Greenwich reasury
Advisors to evaluate its clients FX risks.
In ternationa l Treasurer/Ma rch 6, 1995
Option contracts
Putting our Eggs
in One Basket
Basket options are a popular concept
but
some
corporates prefer
having
more than one option when managing
a portfolio of different risks.
Th e co nceptua l
appea
l
of basket
options is that they h
arness
the diversi
fication effects of a portfolio of expo
sures and reduce the cost of opt io n
coverage by using a single optioQ_con
tract: a basket
option
. Thu s, using a
basket option becomes a low-cost way
for central ized
ri sk management pr
o-
grams to hedge the domest ic va lue of a
basket of currency or other exposures.
Grouping negatives
The reduct ion in cost- compared to a
basket of opt
ions hedging each expo
su re independentl y- is achi eved by
constru ct ing a portfo li o of exposur
es
that are imperfect ly or negative ly co r
related see table
belowL
and hedging
this portfolio with a single option that
is tailored to each of th e portfolio
co
mp
nents (e.g. FX exposures) .
It
is
erivative
Instruments
this negative corre lation between the
exposure compone
nt
s that r
ed
u
ces
the
ove rall vo lati li ty of the portfol io and
thus the price the
opt
ion hedge.
As Stephen Godfrey fro m Bank of
America' FX advisory group notes in
the latest issue of its
Curr
ency Review,
these cost
sav
in
gs
come at the cost of
upside potential. Because the va lue of
the option, and upside
pa
rti cipation, is
linked to the
va
lue of the underlying
portfolio
or
basket as a whole, some of
the upside potential of any component
of the
portfolio
is given up.
Thus, basket options
are not the best
vehicle for
profiting on currency views
through active management-i.e. a
basket option is designed
to appeal to
the cost-center rather than the profit
center mentality.
One stop shopping
As Demetri Papacostas, w ith Chase
Manhattan's options group notes, bas
ket options make a lo t of
se nse for
clients who say
I
spe
nd X amount of
dollars every year on option premiums
and I would like that X amount to be
l
ess
. As he describes t hem, basket
options a l lo w a corporate to take
advantage of thei r existing underlying
exposures - e.g. to un corre
l ated
con tinued on back page
Correlat ion Positions Diversification Bas ke t option price generaiiY:l
Hi
gh pos itive
· (va lUes nea r
+1 )
High posit ive
v
a lues near
+1 )
Low positi ve,
Low n
egat
ive
lu between
.5
and
-.5)
A
lo ng 01
a short
Some
l
ong
and
some
short
A
long or
a
short
Low
Hi gh
Hi gh
High negative A long or Hi gh
va lues around -1
)
a
short
Hi gh
ne
gat ive
Some
long a nd Low
va lues around -1 ) so me short
Source: Bank of America Currency Review, M arch 7995
Cl
ose
to a ask
et
of
opt
ions
Tn ot
mud1 cost savings)
Cheaper
tha n a basket of
I ptions substa ntia l cost sav in gs)
Cheaper than a basket
of
options substanti a l cost savi ngs)
I
I
I
heaper than a basket of
options
substantia l
cost
sav i
ngs)
1
c lose
to
a basket of opt ions
(not muc h
cost
sav in gs)
5