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Foreign Exchange Risk Management . Timothy J. Gilbert Global Transaction Services Foreign Exchange Solutions 617-994-7185 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

Foreign Exchange Risk Management

Timothy J. Gilbert

Global Transaction Services

Foreign Exchange

  • Risks and Management of Exposure
  • Products and Strategic Thinking
one year eur usd
One Year EUR/USD…

Volatility in the Markets




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

managing currency risk
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
should i be concerned about currency risk
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?
currency risk management process
Currency Risk Management Process

Establish Risk Management Policy

Exposure Identification

Establish Budget Rates

Evaluate Hedge Performance

Execute Hedging Strategy


developing a corporate risk management policy
Developing a Corporate Risk Management Policy
  • Management Objective
  • Hedge Philosophy
  • Organizational Issues
  • Audit Issues
  • Risk Management Tools
  • Evaluating Hedging Program

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.)
transaction risk
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

translation risk

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
economic risk
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



hedge consideration
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
product offering foreign exchange solutions
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.

the forward rate
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
foreign currency accounts
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
the global economy
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)

strategic thinking for currency payment solution
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