Transaction 1 2006 MAR 1 G150,000 2006 MAR 1 50,000 101 301 G1.
Transaction Exposure G1
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Transcript of Transaction Exposure G1
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Transaction exposure
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p
Types of Foreign Exchange
ExposureResulting from Accounting
Transaction Exposure
Impact of settling outstanding obligations
entered into before change in exchange rates
but to be settled after change in exchange
rates.
Translation Exposure
Changes in income and owners equity in
consolidated financial statements caused by a
change in exchange rates.
Resulting from Economics
Operating Exposure
Change in expected future cash flows arising
from an unexpected change in exchange rates
Changes in future cash flows arising from firm
and competitor firm responses
Time and Exchange Rate Changes
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Transaction Exposure
Foreign exchange exposure is a
measure of how much the profitability,
net cash and market value for a firm
could change because of variations in
exchange rates.
Transaction exposure measure changes
in the value of outstanding financial
obligations incurred prior to a change
in exchange rates but not due to be
settled until after the exchange rates
change.
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Why Hedge?MNEs possess a multitude of cash flows that
are sensitive to change rates, interest rates,
and commodity price.
Hedging Defined
Many firms attempt to manage their
currency exposure through hendging, which
is the taking of a position, either acquiring a
cash flow, an asset, or a contract that will
rise (fall) in value and offset a fall (rise) in
the value of an existing position.
A firm that hedges its currency exposures
reduce the variance in the value of its future
expected cash flow.
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The Pros and Cons of HedgingPros Cons
Reduction in risk of future cash flows improvesthe planning capability of the firm
Shareholders are more capable of diversifyingcurrency risk than is the management of the firm
Reduction of risk in future cash flows reduces the
likelihood that the firms cash flows will fall
below a level sufficient to make debt-service
payments in order for its continued operation
Currency hedging does not increase the
expected cash flows of the firm
Management has a comparative advantage over
the individual shareholder in knowing the actual
currency risk of the firm
Management often conducts hedging activities
that benefit management at the expense of the
shareholders
Markets are usually in disequilibrium because ofstructural and institutional imperfections, as well
an unexpected external shocks
Managers can not outguess the market
Managements motivation to reduce variability is
sometimes driven by accounting reasons
Hedging would only add cost
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The Pros and Cons of Hedging
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Measurement of
Transaction Exposure
Purchasing or selling on credit goods orservices when prices are stated in foreigncurrencies.
Borrowing or lending funds whenrepayment is to be made in a foreigncurrency.
Being a party to an unperformed foreign
exchange forward contract.
Otherwise acquiring assets or incurringliabilities denominated in foreigncurrencies .
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The Life of Transaction Exposure
The total transaction exposure consist of quotation, backlog,
and billing exposure.
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Hedging accounts receivable:
Exporters caseselling 90d in USD
Ac. Receivabl 1,000,000 USD 1,000,000 USD dollar payment
to be received in 3 months
January 2006 March 2006
Client pays us in USD
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Hedging accounts receivable:
Exporters case1st way:
Ac. Receivable 1,000,000 USD 1,000,000 USD dollar payment
to be received in 3 months
January 2006 March 2006
3.305 S/./USD Spot Rate (Buy) 3.350 S/./USD Spot Rate March 06 (Buy) ?
3.307 S/./USD Spot Rate (Sell) 3.351 S/./USD Spot Rate March 06 (Sell) ?
3.311 Expected Rate March 06 (Buy)
3.312 Expected Rate March 06 (Sell )
1,000,000 USD
4) Receives S/. due to spot rate
3,350,000 S/. ?
3) Sales $ at spot rate on March 06
1,000,000 USD
2) Receives payment from buyer in USD
Unhedged
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Hedging accounts receivable:
Exporters case2nd way:
Hedge in the forward market
Ac. Receivable 1,000,000 USD 1,000,000 USD dollar payment
to be received in 3 months
January 2006 March 2006
3.305 S/./USD Spot Rate (Buy)
3.307 S/./USD Spot Rate (Sell )
Annual 90 days I nterest Rates
Investment US Borrowing US Investment S/. Borrowing S/.
5.358% 5.858% 4.900% 5.160%
Forward contract ER for selling in 90 days: 3.305445187 S/. /USD
Sport Rate (Sell) (1+ER S/. borrowing)90/360
(1+ER $ investment)90/360
1,000,000 USD
4) Receives S/. due to forward sa le
3,305,445 S/.
3) Sales $ due to forward sale
1000000 USD
1) Enters a Forward Contract for selli ng $ in 90 days 2) Receives payment from buyer in
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Hedging accounts receivable:
Exporters case3rd way:
Hedge in the money market
Ac. Receivabl 1,000,000 USD 1,000,000 USD dollar payment
to be received in 3 months
January 2006 March 2006
3.305 S/./USD Spot Rate (Buy) Annual 90 days Interest Rates WACC
3.307 S/./USD Spot Rate (Sell) Investment US Borrowing USD 10%
5.358% 5.858%
985,566 USD
1.1) Convert amount to S/. at spot rate 1,000,000 USD
3,257,297 S/. 4) Equivalent of amount borrowed 90 days
3,338,729 S/.
3) Pays loan in $ (principal + interest)
1000000 USD
1) Borrows $ in order to pay in 90 d (principal + interest) amount of Ac. Receivable
2) Receives payment from buyer in USD
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Hedging accounts receivable:
Exporters case4th way:Hedge in the options market
Ac. Receivable 1,000,000 USD 1,000,000 USD dollar payment
to be received in 3 months
January 2006 March 2006
3.305 S/./USD Spot Rate (Buy) 3.350 S/./USD Spot Rate March 06 (Buy) ?
3.307 S/./USD Spot Rate (Sel l) 3.351 S/./USD Spot Rate March 06 (Sell) ?
Strike Premium Cost WACC
Put option (Right, no obligation to sell ) 3.306 0.701% (Size*Spot) 10%
1,000,000 USD 1,000,000 USD
If March 06 Exchange Rate < Strike
3,306,000 S/.
3) Excercise put option sell $
1.1) Pays premium cost of option in S/. 1000000 USD 3,282,253
23,168.05 S/. 5) Equivalent of premium cost 90 days
23,747 S/.
1,000,000 USD - 1,000,000
If March 06 Exchange Rate > Strike
3,350,000 S/. ?
3) Allow option to expire
1.1) Pays premium cost of option in S/. 0 1000000 3,326,253
23,168.05 S/. 5) Equivalent of premium cost 90 days
23,747 S/.
1) Purchase a put option on amount Ac Receivable in $ 2) Receives payment from buyer in USD
4) Exchange USD to S/. in spot market
2) Receives payment from buyer in USD1) Purchase a put option on amount Ac Receivable in $
4) Receive S/. due to put option
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Hedging accounts receivable:
Exporters caseComparison 4 ways:
Ac Receivable S/.
3,370,000 unhedged
3,360,000
3,350,000 put option
3,340,000
3,330,000 money market: 3,338,729
3,320,000
3,310,000
3,300,000 forward: 3,305,445
3,290,000
3,280,000 put option: 3,282,253
3,270,0003.27 3.28 3.29 3.30 3.31 3.32 3.33 3.34 3.35 3.36 3.37 Spot rate
3.305 Forward Rate
3.306 Strike Rate
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Hedging accounts payable:
Importers case paying 90d in USD
Ac. Payable 1,000,000 USD
January 2006 March 2006 1,000,000 USD dollar payment
to be made in 3 months
We pay to supplier in USD
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Hedging accounts payable:
Importers case -1st way:
Unhedged
Ac. Payable 1,000,000 USD
January 2006 March 2006 1,000,000 USD dollar payment
to be made in 3 months
3.305 S/./USD Spot Rate (Buy) 3.350 S/./USD Spot Rate March 06 (Buy) ?
3.307 S/./USD Spot Rate (Sell) 3.351 S/./USD Spot Rate March 06 (Sell) ?
3.311 Expected Rate March 06 (Buy)
3.312 Expected Rate March 06 (Sell )
1,000,000 USD
3,351,000 S/. ?
4) Pays amount to supplier in USD
1,000,000 USD
2) Pays S/.at spot market
2) Receive $ at spot market
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Hedging accounts payable:
Importers case -2nd way:
Hedge in the forward market
Ac. Payable 1,000,000 USD
January 2006 March 2006 1,000,000 USD dollar payment
to be made in 3 months
3.305 S/./USD Spot Rate (Buy)
3.307 S/./USD Spot Rate (Sell)
Annual 90 days Interest Rates
Investment US Borrowing US Investment S/. Borrowing S/.
5.358% 5.858% 4.900% 5.160%
Forward contract ER for buying in 90 days: 3.297497043 S/. /USD
Sport Rate (Buy) (1+ER S/. investment)90/360
(1+ER $ borrowing)90/360
1,000,000 USD
3,297,497 S/.
4) Pays amount to supplier in USD
1,000,000 USD
1) Enters a Forward Contract for buying $ in 90 days 2) Receive $ due to forward purchase
3) Pays S/. due to forward purchase
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Hedging accounts payable:
Importers case -3rd way:
Hedge in the money market
Ac. Payable 1,000,000 USD
January 2006 March 2006 1,000,000 USD dollar payment
to be made in 3 months
3.305 S/./USD Spot Rate (Buy) Annua l 90 days I nteres t Rates WACC
3.307 S/./USD Spot Rate (Sell) Investment US Borrowing USD 10%
5.358% 5.858%
1,000,000 USD
1) Exchange S/. to $ at spot rate to invest in an account 1,000,000 USD4) Equival ent of amount invested 90 days
3,263,288 S/. 3,344,870 S/.
1.1) Invest in USD for 90 days period
986,782 USD
2) Receive $ due to investment in bank
3) Pays a mount to supplier in $
to receive (principal+interest) amount Ac.Payable
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Hedging accounts payable:
Importers case -4th way:Hedge in the options market
Ac. Payabl e 1,000,000 USD
January 2006 March 2006 1,000,000 USD dollar payment
to be made in 3 months
3.305 S/./USD Spot Rate (Buy) 3.301 S/./USD Spot Rate March 06 (Buy) ?
3.307 S/./USD Spot Rate (Sell) 3.302 S/./USD Spot Rate March 06 (Sell) ?
Strike Premium Cost WACC
Call option (Right, no obligation to buy) 3.306 0.701% (Size*Spot) 10%
1,000,000 USD
1,000,000 USD
3) Pays S/. For the option at strike
1.1) Pays premium cost of option in S/. 3,306,000 S/. 3,329,762
23,182.07 S/.
1,000,000 USD
5) Equivalent of premium cost 90 da ys
23,762 S/.
1,000,000 USD 2) Allow option to expire
If March 06 Exchange Rate < Strike
1,000,000 USD
1.1) Pays premium cost of option in S/. 3,302,000 S/. ? 3,325,762
23,182.07 S/.
1,000,000 USD
5) Equivalent of premium cost 90 da ys
23,762 S/.
3) Exchange S/. To USD in spot market
3) Pays amount to supplier in $
If March 06 Exchange Rate > Strike
2) Excercise call option to buy $
1) Purchase a call option on amount Ac Payable in $
4) Receive USD from spot market
4) Pays amount to supplier in $
1) Purchase a call option on amount Ac Payable in $
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Hedging accounts payable: Importers
caseComparison 4 ways:
Ac Payable S/.
3,370,000 unhedged
3,360,000
3,350,000
3,340,000 money market: 3,344,870
3,330,000
3,320,000 cal l option: 3,329,762
3,310,000 cal l option
3,300,000
3,290,000 forward: 3,297,497
3,280,000
3,270,000
3.27 3.28 3.29 3.30 3.31 3.32 3.33 3.34 3.35 3.36 3.37 Spot rate
3.297 Forward Rate
3.306 Strike Rate
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Companies have to deal with foreign exchange exposure, it is
the result of opening to world markets.
Hedging is a way to reduce the risk to this exposure, with its
advantages and disadvantages.
It could improve the capability of reaction of the company toforeign factors.
A firm that hedges its currency exposures reduce the variance
in the value of its future expected cash flow.
There are three alternatives to hedge against currencyexposure and there is the alternative of remain un-hedged. To
choose the best of the three alternatives the CFO has to own a
position on the future exchange rate.
Conclusions
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Thank you!!