Currency Risk Management Overview

Thomas A. Armes

Vice President

Currency Risk Management

•It is the world’s largest market with daily trading volumes in excess of $1.5 Trillion. Compare to the NYSE with daily volumes of $60 Billion.

•Interbank and Over-the-Counter market with three major trading centers – London 30%, New York 20%, and Tokyo 12%.

•A truly 24 Hour market that begins Sunday at 3 PM EST, which is Monday morning in Sydney and ends Friday at 4:30 PM EST with the New York Close.

•Currencies are often identified by a three letter ISO (International Standards Organization) code. Examples of major currencies, EUR – European Euro, GBP - Great Britain Pound, CHF – Swiss Franc, CAD – Canadian Dollar, AUD – Australian Dollar, NZD – New Zealand Dollar, and JPY - Japanese Yen.

•Currency Nicknames – Sterling, Cable, Aussie, Kiwi.

•Currency Size Nicknames – 1 Dollar = 1 Million, 1 Yard = 1 Billion, 1 Pip = The last significant digit in the quoted rate. Ex: EUR/USD 1.1253, three is the pip.

FX Market Description

•Consumers – typically convert currency prior to traveling. Often referred to as a “retail” client.

•Businesses – convert currency if they are conducting business outside of their home currency. Often referred to as a “corporate” client. Example: A company the size of GE converts tens of billions of dollars each year.

•Hedge Funds, Mutual Funds, and Private Investors – convert currency to diversify their investment portfolio into foreign investments such as equities, bonds, bank deposits, or real estate. Speculators can also trade currency for the sake of trading without an underlying asset.

•Commercial and Investment Banks – trade currencies to support the needs of commercial banking, deposit, and lending customers.

•Governments and Central Banks – trade currencies to intervene and affect that rate of exchange to offset economic or financial imbalances.

Market Participants

•Transaction Exposure - Differential in FX rates from the time of sale to actual payment or receipt.

•Competitive Exposure - Based upon how a company chooses to conduct business internationally - includes pricing/sourcing.

•Translation Exposure - Risk in conversion of assets and liabilities from the functional currency to the base currency (i.e. consolidation of a foreign subsidiary onto a parent companies balance sheet).

•Fundamental/Political Exposure -The political environment often affects the valuation of currencies, also known as, sovereign risk.

Currency Risk – What is it?

Typical Corporate Hedge Solutions

•Spot Contracts - One or Two day value to process foreign denominated payable/receivable (Largest Volume).

•Forward Contracts - Longer Values, typically up to 1 year, used to lock-in exchange rate and hedge fluctuations of foreign payable/receivable. Can require credit consideration.

•Option Contracts - Used to establish a position in a currency with upside participation and downside protection, usually requires an initial premium, some positions can be assumed without paying a premium. Minimum amount $500,000. Requires credit consideration.

Forward Contracts

•90% of corporations that hedge foreign currency exposure for 1 Year or less use forward contracts.

•How are forward rates calculated? Interest Rate Differential.

Example: You need to sell 100,000 EUR in Three Months

Spot Rate 1.3000

USD Libor 3 Month = 2.50%

Euribor 3 Month = 2.15%

EUR 100,000 + ((100,000 * 2.15%)/360))*90) = 100,537.50

USD 130,000 + ((130,000 * 2.50%)/360))*90) = 130,812.50

130,812.50/100,537.50 = 1.3011

1.3011 – 1.3000 = .0011 These are the forward points

Forward ExampleTransaction Exposure

1.2500

1.2600

1.2700

1.2800

1.2900

1.3000

1.3100

1.3200

1.3300

Dates

Rat

e Spot Rate

30 Day Forward

Vanilla Put Option (2% Premium)Transaction Exposure

1.25001.26001.27001.28001.29001.30001.31001.32001.3300

Date

Rat

e

Spot Rate

Strike Price

Break Even

Zero-Cost Collar ExampleTransaction Exposure

1.25001.26001.27001.28001.29001.30001.31001.32001.3300

Date

Rate

Spot Rate

Participation Level

Protection Level

Treasury Management Solutions

•Online Foreign Exchange - Convenience of trading directly from desktop and the ability to access dynamic reporting features.

•Foreign Currency Transaction Accounts - Non-Interest bearing foreign denominated accounts held by SunTrust at a correspondent bank, allows for netting (matching of payables/receivables in foreign currency).

•Canadian Lockbox Facility – Allows our corporate clients to accelerate Canadian dollar receivables. US Corporations can achieve “local business” presence in markets where they do not have a physical office.

Asset/Liability Solutions

•Foreign Denominated Loans - Borrowing in a foreign currency, allows flexibility.

•Time Deposits in Foreign Currencies (CD’s) - Take advantage of favorable exchange rates or interest rates in foreign countries. Varying maturities with a minimum amount of $100,000.

•Currency Swaps – an agreement between two parties in which one party promises to make payments in one currency and the other promises to make payments in another currency. Currency swaps give companies extra flexibility to exploit their comparative advantage in their respective borrowing markets. Typically longer than 1 year and requires credit consideration.

•Non-Dollar Interest Rate Swaps – an agreement between two counter-parties under which each agrees to make period payments to the other for an agreed period of time based upon a notional amount of principal. Typical transaction is where our corporate client has a floating rate currency loan and would like to fix the rate.

Why not Price in $USD?

•Importers –

If paying in USD then importers are often subjected to a price that has a built in cushion to accommodate the FX risk that is being taken on by the supplier. Typically importers can save 3-5% by paying in the local currency.

Importers should request dual-billing so that they have the ability to pay in the most beneficial currency at time of payment. Also, they will be able to calculate the implied exchange rate.

•Exporters –

Competitive advantage from pricing in local currency. Especially in low-margin or commodity type businesses.

Questions?