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Foreign Exchange Risk Management . Timothy J. Gilbert Global Transaction Services Foreign Exchange Solutions 617-994-7185 [email protected] Agenda. Risks and Management of Exposure Products and Strategic Thinking. One Year EUR/USD…. Volatility in the Markets.

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Foreign exchange risk management l.jpg

Foreign Exchange Risk Management

Timothy J. Gilbert

Global Transaction Services

Foreign Exchange [email protected]

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  • Risks and Management of Exposure

  • Products and Strategic Thinking

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One Year EUR/USD…

Volatility in the Markets

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While Short Term Currency Volatility Can Be Substantial, Observed Over Several Years, Currency Movement Can Significantly Impact The Competitive Position Of Global Companies, Importers And Exporters

Short term volatility, while still significant, is overshadowed by the long term trend, particularly with regard to competitive positioning.

Chart Data Source: Bloomberg

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Managing Currency Risk

  • Movements in foreign currencies can have a significant impact on corporate performance

    • Cash Flows, Earnings, Balance Sheet

  • Allows companies to focus on core business, not foreign exchange

  • Effective management of currency risk can be a source of competitive advantage

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    Should I be Concerned about Currency Risk?

    • What is the nature of your company’s product or service?

      • Is it a commodity? Are substitutes readily available?

      • Are the margins sufficient to absorb a currency shock?

      • How frequently can you change your prices?

      • Can you pass on increased costs to your customers in the form of higher prices?

  • Competitive Position

    • Is your firm a price-maker or price-taker?

    • What is the functional currency of your competitors?

    • In what currencies do your competitors sell their products or services?

  • Impact on Earnings/Balance Sheet

    • Does a 2 standard deviation move in exchange rates have a meaningful impact on your reported earnings?

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    Currency Risk Management Process

    Establish Risk Management Policy

    Exposure Identification

    Establish Budget Rates

    Evaluate Hedge Performance

    Execute Hedging Strategy


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    Developing a Corporate Risk Management Policy

    • Management Objective

    • Hedge Philosophy

    • Organizational Issues

    • Audit Issues

    • Risk Management Tools

    • Evaluating Hedging Program

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    Corporate FX Exposure Overview

    Transaction Exposure

    • The cash flow exposure that results from cross border activities in non-functional currencies; these may be third party or inter-company (i.e. trade sales/payables, debt, royalties/license agreements, etc.)

      Translation Exposure

    • The exposure that results from translating non functional currency assets or liabilities into the functional currency

    • The exposure that results from consolidating a foreign denominated income statement in the parent’s reporting currency

    • The exposure that results from translating the local currency financial statements of foreign subsidiaries into the functional currency of the parent

      Economic / Competitive Exposure

    • The exposure that arises when exchange rate changes affect the firm’s ability to conduct business in a competitive and profitable manner

    • What is the impact of exchange rates on competitors?

      Contingent Exposure

    • Foreign exchange exposure arising from a potential future transactional event (i.e. potential acquisition or divestiture, bid-to-award risk, etc.)

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    Transaction Risk

    • The US dollar equivalent value of international transactions denominated in a foreign currency will change as the exchange rate changes

    • Includes forecasted and booked transactions

      • Accounts Payable

      • Accounts Receivable

      • Foreign Currency Denominated Debt/Inter-company debt

      • Capital Equipment Purchases

      • Transactions that may occur in the future, such as being awarded a contract

      • Declared Dividends

    • A cash flow risk

      • Gains and losses impact income statement

    U.S. Imports

    Payment in Yen

    U.S. Exports

    Receipt In Euros

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    GBP = ??? USD

    USD Functional

    GBP Functional

    Translation Risk

    • The risk that a company's net assets, or income will change in value as a result of exchange rate changes. Sometimes referred to as accounting exposure.

    • Balance Sheet Exposures occurs when consolidating overseas (non-US dollar) net asset position with those of the parent company.

      • Balance Sheet items consolidated at period end rates

      • Gains and losses impact equity

    • Income Statement Exposure occurs when consolidating overseas earning (non-US dollar) with the income of the parent company.

      • Income Statement items consolidated at period average exchange rate

    • A non-cash risk

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    Economic Risk

    • Competitive advantages or disadvantages resulting from exchange rate fluctuations that impact the value of a firm. Affects a company’s earnings, cash flow and foreign investments.

    • Difficult to identify, quantify, and hedge since this exposure could be to a currency in which your company has no physical activity

      • Example:

        • you have a dollar cost base and sell all of your finished goods in the US

        • your main competitor has a Peso cost base

        • your competitiveness in the US markets will be influenced by the Peso /US dollar exchange rate

    US Local Operator

    USD Costs/USD Pricing

    US Importer

    Peso Costs/USD Pricing

    US Importer

    CAD Costs/USD Pricing



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    Hedge Consideration

    • What amount to Hedge?

      • Because of uncertainties with all forecasts, it is sound not to hedge the whole exposure.

      • High level confidence in forecast, hedge between 75% to 90%.

      • Lower level of confidence or general uncertainty, hedge 25% to 50%.

    • Corporate Hedging Issues

      • “Hedge everything” policy

      • Prohibition on changing positions

      • Strict loss limits

      • Hedging for profit

      • Hedging by Committee

      • 20/20 Hindsight

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    Product Offering - Foreign Exchange Solutions

    Spot Contracts – Secured Settlement

    Spot Contracts provide a contractual foreign exchange rate for a specific amount of currency for delivery (or sale) in one or two business days, depending on the country.

    Forward Contracts

    Forward Contracts offer a firm foreign currency conversion rate on a specified amount of currency for a specified date or range of dates.

    Swap Contracts

    Swap Contracts are typically used when the maturity of an existing forward contract needs to be shortened or extended.

    Foreign Currency Options

    Option Contracts give the customer the right, but not the obligation, to buy or sell a specific amount of currency against another at a predetermined strike price and at a specific maturity date.

    Foreign Currency Accounts

    Foreign Currency Accounts can offer flexibility in managing foreign cash flows by minimizing the need for currency conversions.

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    The Forward Rate

    • The forward rate is the rate which neutralizes differences in interest rates across currencies, making you indifferent as to which currency you are invested.

      • It is notthe bank’s/ market’s projection for future spot rates.

  • In practice, traders quote ‘forward points’ which are added or subtracted from the spot rate to obtain the forward rate (aka All-In rate).

    • Forward Rate = Spot Rate + Forward Points

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    Foreign Currency Accounts

    • Foreign Currency Accounts (FCA)

      • Accounts held in foreign currency

      • Savings and Transactional accounts available

      • An excellent method of cash flow management if company pays and receives funds in foreign currency – Natural Hedge

      • Can be used in conjunction with online systems and supplemental hedging solution

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    The Global Economy

    Cross-Border Payments and the need to be flexible with local currencies

    More than $3 trillion in transactions processed per day

    Risk for any company conducting cross-border payments

    USD cash flow risk with global competition

    Exporters at risk - USD cash flow

    Payments delayed anticipating more favorable exchange rates

    Lost sales opportunity due to customer choosing product priced in local currency

    Importers at risk - USD cash flow

    Overpayment or underpayment due to adverse currency fluctuation

    High value at risk (speculative-driven vs. customer-driven)

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    Strategic Thinking for Currency Payment Solution

    To remain competitive companies should take steps to navigate the challenges of cross-border payments

    Decrease risk and increase control by determining the best channel for processing payments

    Consider technology for optimizing working capital

    Evaluate Global payment solutions for flexibility and convenience with currency offering, foreign currency accounts, and network

    Access to more advanced solutions in hedging and managing exposure