Aracruz
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Transcript of Aracruz
ARACRUZ Brazilian company that lost over U$2 billion due to exchange rate movements resulting from the
financial crisis of 2008
Aracruz used 6 types of derivatives during 1999-2008 to hedge its position :
Standardized derivatives : 1) Standard future contracts 2) Currency couponsOTC derivatives :3) Non deliverable forwards (NDF)4) Conventional swaps5) An exotic swap with monthly
settlements 6) A structured derivative : sell target
forward
Aracruz was the major Brazilian manufacturer of pulp and paper with steady growth in revenue, output and profits throughout 1999-2007.• the biggest world producer of bleached eucalyptus pulp• net revenue : U$1.42B & 26% of world market • market capitalization of U$7.1B (July 8th, 2008) & BBB flat rating by Moody’s ,
S&P
• Losses of U$2.13B in derivatives posted
• ~ 3.7 times of 2007 EBIT
• ~ 30% of Aracruz’s market capitalization
• Stock plunge > 90% in 3 months,
• Acquired by another cellulose producer in 2009.
1999 2001 2003 2005 2007 20092008
Aracruz (1999-2009)
2007 2008 2009 2010 2011
80
60
40
20
6M
4M
2M
Share Price
Volume
Share prices take a nose dive
Optimal & Effective Hedge
Aracruz Optimal and Real Hedge (US$ million) – 1999-2008
Aracruz Foreign Currency Liabilities and Assets, and Derivatives Short position (US$ million) – 1999-2008
Expectation (1,6,12 months) and Effective Exchange Rate – US$/R$ – 2003-2008
Effective Exchange Rate – US$/Real and S&P500 – 08/28/2008 to 10/02/2008
SOURCE: Report-The Failure of Risk Management for Non-Financial Companies in the Context of the Financial Crisis
Shifting Focus toSell Target Forwards Aracruz started to invest in Sell Target Forwards in
2008 Sell Target Forwards allowed Aracruz to “double
hedge” the exchange rate risk:1. Traditional dollar forward sale – the standard hedging
for currency risk2. Then sold the same dollar again via a “call option” –
where the speculation and the scandal starts Sell the same dollar again Taking the same short position on the $ The problem is that the second position has a strike price
where the bank will call the option which constitutes a ceiling. But there is no floor…
…continuedThe contract is valid for a year with
monthly settlements => is equivalent, for Aracruz, of selling 12 calls with successive monthly strike dates, and also 12 NDFs.
P/L = 2nt *( X – S ) P/L % = 2*12 *( X- 1.5X ) *100/1.5X = 800%n: notional amount , t: time left in the contract,
X: strike price ; S: actual price.
Scandal ???Far greater exposure to the derivatives than was
necessary to hedge against the USD riskMolding its hedging activities towards creating risk
rather than minimizing it
Severe violations of the company’s hedging policyStrategy deviated from share-holder protection
towards making money from betting….Agency problem – poor corporate governance
because too much discretion given to CFO