Currency Risk Management

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Austin Missoula Manila

Empirical Solutions, LLC

Preemptive Currency Risk Management


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Empirical Solutions

Empirical Solutions PREEMPTIVE RISK MANAGEMENT | Protect. One Client at a Time.

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We help our clients generate consistent results. We:

1. Reduce FX earnings risk and protect their balance sheet2. Save clients money and reduce their cost of hedging3. Reduce the staffing needed to support a world class hedging

program so they can focus on their core business

We are paid only by our client, and therefore we can and doprovide conflict-free advice and act as their unbiased advocate.

NOTE: We do NOT pretend to know the future. That is whywe encourage clients to hedge and avoid risky speculation.

EMPIRICAL: Who are we? What do we do?

Copyright 2013 Empirical Solutions, LLC. All rights reserved. www.empiricalresults.net


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Prediction is very difficult, especially about the future. (NielsBohr, the famous Danish physicist)

Having endeavored to forecast exchangerates for more thanhalf a century, I have understandably developed significanthumility about my ability in this area. (Alan Greenspan, formerU.S. Federal Reserve Chairman)

If you think writing about the fortunes of the stock market istricky, try getting your arms around currencies. (Bill Gross, Co-

Founder of Pacific Investment Management and manager ofPIMCO's $270.0 billion Total Return Fund)

NOBODY HAS A CRYSTAL BALL THAT ALWAYS WORKS



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WHAT ONE THING DO ALL THESE FIRMS HAVE IN COMMON?



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FX RISK MANAGEMENT ROADMAP

1. Quantifying Currency Risk: The Bottom Line Impact

2. Explore FX Impact: Where Does It Affect Your Company?

3. Which Firms Hedge Today?

4. Benefits of Hedging

5. Hedging Best Practices

6. Background on Empirical Solutions, LLC

7. Next Steps?



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! Crises are a reoccurring phenomenon (Asia 97, Russia and LTCM 98,9/11/01, Lehman 08, Greece 10/12, Cyprus 13).

! Currency controls have never worked over longer periods of time (BrettonWoods, ERM, Plaza Accord, Jamaica Agreement).

! Central banks continue to actively intervene in currency values (Bank ofJapan, China, Swiss National Bank, and the U.S. FED etc.).


CURRENCY RISK: An old problem.


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Empirical SolutionsEmpirical Solutions PREEMPTIVE RISK MANAGEMENT | Protect. One Client at a Time.

7Copyright 2013 Empirical Solutions, LLC. All rights reserved. www.empiricalresults.net

CURRENCY RISK: Overview of VAR (Value at Risk).

Mean

Spot

VaR is a method of quantifying potential loss in uncertain situations. VaRmeasures the value of loss which is unlikely to be exceeded a defined % ofthe time, called the confidence interval (CI). For example, a 95% $1mmVaR, means that 95% of the time, the loss will be $1mm or less.

In this presentation, we only refer to the left tail which referspurely to the probability of losses (left-hand side of the normalprobability curve, shown on the left).

For example: a 95% Annual VaR on a $1mm contract,

assuming annual vol=13% is calculated as follows:95% VaR = z-value*StdDev (annual)*contract value

95% VaR = 1.64*13%*$1M = $213,200 risk per year.

Correct interpretation: 95% of the time, the probable lossof that contract would be no more than $213,200 but 5%

of the time it is expected to be larger than $213,200.


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CURRENCY RISK: Volatility is not limited to longer periods of time.

6 months

5 years

USDPHP CADPHP AUDPHP

36-4739-4740-49

41-45 40-46 36-44

Note: 5 year data reflects most recent data but to make the point that short term moves can be significant, the6 month charts reflect one of the higher volatility 6 month periods within the last 5 years.


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CURRENCY RISK: Currency risk can often exceed profit margins.

0

5

10

15

2025

30

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USDPHP CADPHP AUDPHP

1 Year

3 Year

5 Year

Value at Risk on $100M Notional


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7. Next Steps?



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FX IMPACT: How does FX affect your business today?

These questions can help us understand how FX affects your business:

" Does your firm receive payments in foreign currencies?" Does your firm ever pay expenses in foreign currencies?" Do you have foreign denominated assets?" Do you have any debt that is denominated in another currency?" Do you customershave foreign currency risk?" Does your competition (even if you do not) have foreign currency exposure?" Do your suppliers have currency risk imbedded in their business?" If you do hedge, do you have a formal (written) hedging policy in place?" How does your firm measure FX risk and measure hedge effectiveness?" What procedures do you follow to minimize the cost of hedging?" Do you thoroughly hedge or sometimes take a speculative view on rates?

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7. Next Steps?



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13Disclaimer: Currency trading carries substantial risk of loss, is not for everyone and only risk-capital should be used.Proprietary and Confidential. ( Copyright 2012 Empirical Solutions, LLC. All rights reserved.)

NEARLY ALL GLOBAL LEADERS HEDGE THEIR FX RISK.


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! Mainstream and considered a best-practice.! Hedging is GAAP compliant since 1998. FASB has established standard

accounting procedures for hedging in US and IASB for the rest of the world.


HEDGING: A widely recognized best practice.


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7. Next Steps?



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1. More predictable earnings. Good for Investor Relations (IR).2. Protect the reputation of your firm, by not letting negative stories about forex

losses cloud operating accomplishments in the core business.

3.

Greater access to capital. Investors put a premium on management thatprioritizes risk-management as well as growth.

4. Less volatile companies get better borrowing terms.5. Investors reward more stable firms with higher public valuations.6. Stop and imagine the damage to team morale if an entire years worth of

hard work is erased by FX risk that could have been hedged. What is thevalue of protecting the enthusiasm of hard working employees?

7. Minimize cash crunches caused by unexpected currency losses.8. Avoid re-financing risks (such as having to take a loss on existing loan).


BENEFITS OF HEDGING: The benefits are multi-dimensional.

Benefits can include:


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! IPOs! Mergers! Acquisitions! Vendor terms! Bank line negotiation! Investor relations strategy! Sourcing expansion capital


BENEFITS OF HEDGING: It impacts firm-wide strategy.

Hedging can positively impact a wide variety of corporate actions:

The closer we work together, the more effectively we can help you make surethat FX risk does not impact seemingly unrelated areas of your operations.


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7. Next Steps?



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! Hiring outside expertise. Less expensive than hiring experienced full timestaff (minimum of two). Even Fortune 500 firms use external experts.

! Firmly negotiate with the liquidity providers (banks) to get best rates.! Integrate balance sheet and income hedging approach (saves money)! Net exposures to do the least number of transactions (and save fees).! Triangulation and natural hedging for non-G7 currencies in particular.Other Best Practices:! Inclusion of internal and external accountants early in the process.! Analytics track results and sources of variances for accountability.! Consistent hedging policy to avoid the temptation of market timing.


HEDGING BEST PRACTICES: If worth doing, best do it right.

Cost saving best practices include:


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BANKS: Important source of liquidity and conflicts of interest.

Banks provide the products you use to actually hedge. However, just because theyare your bank, does NOT mean they work for you.

Heres an excerpt from a term sheet Empirical Solutions recently reviewed for a Client:


! Bank-proposed hedge structures will often be lowest-risk/highest return forthe bank or will be the products that are easiest to get approved by theircredit department and not necessarily the best ones for you.

! Bank trading agreements (ISDAs) explicitly favor the bank, but most bankswill allow you to add in additional language that helps make it more two-way(but you have to know how to do this and coordinate with attorneys).


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Recent press headlines prove the point:


BANKS: Size does not guarantee good disclosure standards.


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7. Next Steps?



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Empirical: Howwe conduct business makes us different.

! We listen. We ask questions. We want to understand your business.! We prioritize based on yourbusiness objectives (we get paid either way).! We work for you. We have no commercial relationships with vendors.! We do not sell software. We developed our own enterprise class system and

you get the benefit of it as part of retaining us to advise you.! We do not make you use our software (we do the work). This saves your staff

a lot of time. No need to learn and use yet another software system.

! If you use an ERP system like SAP, our program can work seamlessly toleverage the benefit of your ERP reporting power.

!Bottom line, we work to save you money and time and help you reduce risk.


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! Registered Commodities Trading Advisor (CTA) with the CFTC.! NFA Member Approved (ID #0424405).! Management has over two decades of practical, hands-on currency

and risk-management experience.

! Owned by management. No external affiliations (no conflicts).! Clients include both U.S. based firms and international businesses.! Empirical also operates under Currency Risk Management, LLC in both

the United States and in Asia per agreement.

Empirical: Independent and experienced.



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! Existing clients include:! U.S. based firms! International businesses! Publicly traded firms! Private, closely held firms

! Sample of industries served:! A golf and sports gear firm! A large automobile and bicycle retailing operation! A firm that sells imaging systems for manufacturing process control! Publicly listed real estate company

Empirical: We serve many different types of businesses.



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Stefan Whitwell, CFA, CIPM, Managing Director

! Two decades of investment and risk management experience; expertiseincludes both traditional and alternative assets.

! Previous experience includes institutional and hedge fund coverage at CreditSuisse First Boston and Goldman Sachs, and mergers and acquisitions

investment banking at James D. Wolfensohn, Incorporated.! Awarded the Chartered Financial Analyst designation (Charter #40140) in 2000

and the Certificate in Investment Performance Measurement (Certificate#000892) in 2012 by the CFA Institute. Served on one of the CFA Examstandards setting committees for the CFA Institute in the summer of 2012.

! Graduated from the Wharton School at the University of Pennsylvania with aBachelor of Science in economics and concentration in finance.

! Listed with the National Futures Association as Principal, registered as anAssociated Person, Forex Associated Person and Associate Member of theNational Futures Association (NFA ID #0277030).

Leadership



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Paul Stafford, Managing Director

! Founded a currency risk management business; built models used bycorporations for risk management that analytically incorporate a variety ofderivatives and Monte Carlo-based tools to aid decision making.

! Previously worked as an engineer at NASA-Ames Research Center, where hedeveloped liquid helium near-absolute zero cooled infrared sensing arrays, andthe related processing electronics, to extend the observable universe.

! Subsequently recruited by Hewlett Packard Company (Palo Alto) to solve somechallenges calibrating Microwave Vector Signal Generators, which were used togenerate modulation test signals such as Barker-coded radar pulses and

Doppler-shifted satellite signals. Developed a technique for calibrating VectorSignal Analyzers which resulted in a patent (US Patent 5,332,974) that is nowwidely used in the electronics manufacturing business.

! Bachelor of Science degree in engineering from UC Berkeley, and a Master'sdegree in engineering from Stanford University.

Leadership



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7. Next Steps?



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29Disclaimer: Currency trading carries substantial risk of loss, is not for everyone and only risk-capital should be used.Proprietary and Confidential. ( Copyright 2012 Empirical Solutions, LLC. All rights reserved.)

Next steps?

Your Firm


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We manage your entire hedging program for you, determining andhelping execute thehedge structure based on your revenue forecasts and trial balance data.

Data (flat file, CSV) is sent to us via a secure file transfer protocol such as Drop Box orBitTorrentSync. We send remeasurement data, trade execution, accounting rates, hedging

results and variance analysis. We operate the OLAP-based engine so your IT and financepersonnel do not need to learn and operate yet another complex software tool.

IMPLEMENTATION: Overview.


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Day of Month Item Sender

Last Work Day (WD) of month Latest BS, CF forecastAccounting Rate

Trades to be executedAs-executed contract data

CompanyCRM

CRMCompany/Bank

WD+5 (previous month close)WD+6WD+7

Actual NMA, Income statementTrades to be executed

As-executed contract data

CompanyCRMCompany/Bank

Netting Day (typically 3rdWednesday

LC cash delivery (accuracy not critical)Trades to be executed

As-executed contract data

Company

CRMCompany/Bank

IMPLEMENTATION: Schedule of data exchanges and trades.

Note: CRM is the name of Empiricals currency risk management business unit.


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IMPLEMENTATION: Benefit from our world-class FX-Engine.

Clients benefit from the FX-Engine at no additional charge:

1. Excel can only think in two dimensions, but hedging requires manymore (currency, day, month, portfolio, entity, counterparty, forwardrate, natural accounts et cetera).

2. The organization of spreadsheets is often linked to the people thatcreate them, and the expected use for the information. As staffingand risk management requirements change, spreadsheets becomeerror-prone and eventually unusable.

3. Modern OLAP (online analytical processing): Dimensions organizedata into multi-dimensional data cubes.

4. We built and use an OLAP-based FX Risk Engine.

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IMPLEMENTATION: Our Trade Reduction Tool saves clients money.

Less is More (Beneficial):

1. Companies with non-G-7 functional currencies must sometimes hedge crosscurrency pairs.

2. Empiricals Trade Reduction Tool reduces hedging costs in two ways: First wedecompose cross-trades into two equivalent USD-based trades. This reduces

total spread costs. Second, an algorithm then aggregates trades as possible,reducing the total volume of trades. In the example below, 18 cross-currencyhedges have been reduced to only 10 USD-based trades.

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IMPLEMENTATION: We employ the full range of hedging methods.

Here is an example of one hedging method called layering thatdemonstrates how dramatically financial volatility can be reduced:

Monthly GBP costs

Costs Unhedged 6 month avg. 12monthavg.

Std Deviation 179,604 114,369 53,493

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Stefan Whitwell, CFA, CIPM (Austin, Texas)

office: (877) 936-3372 ext. 701

cell: (917) 214-6833

email: [email protected]

Contact Information

Paul Stafford (Missoula, Montana)

office: (877) 936-3372 ext. 702

cell: (406) 546-8410

email: [email protected]

Copyright 2013 Empirical Solutions LLC All rights reserved www empiricalresults net

Currency Risk Management

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