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MBSP 0354 International Finance. Lecture 5 03 NOV 09. DEVISING A FOREIGN EXCHANGE MANAGEMENT STRATEGY. Objectives of Lecture. Introduce the Role of the Treasurer Discuss: External FX Management Strategies Internal FX Management Strategies. Readings:. Buckley: Chapter 10 Chapter 11

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Mbsp 0354 international finance
MBSP 0354International Finance

Lecture 5

03 NOV 09



Objectives of lecture
Objectives of Lecture

  • Introduce the Role of the Treasurer

  • Discuss:

    • External FX Management Strategies

    • Internal FX Management Strategies


Readings
Readings:

  • Buckley:

    • Chapter 10

    • Chapter 11

    • Chapter 32 - 32.3 to 32.5


Centralise or decentralise
Centralise or Decentralise

  • Centralise:

    • Take Decisions at “Group” Level

    • Maybe Cheaper

    • Maybe more Efficient

  • Decentralise:

    • Take Decisions at “Subsidiary Company” Level

    • Maybe more in Line with Devolved Management Responsibility



  • Enter the treasurer
    Enter – The Treasurer

    • Internal BANKER:

      • NOT Accountant

  • Job is to Make Best Use of Internal and External Banking Facilities and Techniques

  • Profit Centre or Cost Centre


  • The treasurer job description
    The Treasurer – Job Description

    • Identify Exposure:

      • Transaction Exposure

      • Translation Exposure

      • Commercial / Economic Exposure

  • Manage Exposure

  • Manage Cash


  • Transaction exposure
    Transaction Exposure

    • Arises from Changes in Spot Rate

    • Affects:

      • Sales Revenue

      • Cost of Sales

      • OverheadCost

  • A Threat to the Profit & Loss Account


  • Transaction exposure1
    Transaction Exposure

    • We Export Washing Machine to Switzerland:

      • Spot Rate CHF 1.90 = GBP 1

      • Sales Price = GBP 200 = CHF 380

      • Costs Total GBP 170

      • Profit = GBP 30


    Transaction exposure2
    Transaction Exposure

    • If Spot Rate Becomes CHF 2.20 = GBP 1:

      • Sales Revenue = CHF 380 = GBP 172.72

      • Costs = GBP 170.00

      • Profit = GBP 2.72

      • Profit Falls by c. 91%


    Translation exposure
    Translation Exposure

    • Arises from Changes in Spot Rate

    • Arises from Holding:

      • Assets

      • Liabilities

  • A Threat to the Balance Sheet


  • Translation exposure1
    Translation Exposure

    • Purchase Office Block / Service Centre for CHF 2,000,000

    • Spot Rate CHF 1.90 = GBP 1:

      • Value is GBP 1,052,630

  • 2 years Later:

    • Value is Still CHF 2,000,000

    • Spot Rate is CHF 2.20 = GBP 1

    • Value is GBP 909,090

    • Translation Loss is GBP 143,540


  • Commercial economic exposure
    Commercial / Economic Exposure

    • Arises from Changes in Spot Rate

    • Results in a Gain / Loss of Market

    • Note Difference between Concept of:

      • Commercial Exposure

      • Economic Exposure

  • “Threat to Long-Term Cash Flow”


  • Commercial economic exposure1
    Commercial / Economic Exposure

    • We Export Washing Machine to Switzerland:

    • Our Price is GBP 200

    • At CHF 1.90 = GBP 1:

      • Our Price is CHF 380

  • German Competitor Sells at CHF 420


  • Commercial economic exposure2
    Commercial / Economic Exposure

    • Spot Rate Changes to CHF 2.25 =GBP 1

    • EUR / CHF Spot Rate Unchanged

    • Our Price Changes to CHF 450

    • German Co’s Price Still CHF 420


    Internal techniques
    Internal Techniques

    • Netting

    • Matching

    • Leading & Lagging Balances

    • Determining Currency of Invoice


    Netting
    Netting

    • Netting End of Period Balances:

      • Same Currency

      • Parallel Currency

  • Simple Example:

    • A Owes B USD 10,000,000

    • B owes A USD 8,000,000

      • Net Debt is from A to B

      • Net Debt is USD 2,000,000

  • Real Life Examples much more Complicated


  • Parallel currency
    Parallel Currency

    • Currencies Closely Linked in their Market Performance

    • 2 year Chart - Spot Rate Euro (EUR) v. Danish Krone (DKK)


    Matching
    Matching

    • Matching Inflows and Outflows of Same Currency

    • Dates of Individual Receipts / Payments Altered

    • Simple Example:

      • A is due to Receive EUR 1,000,000 on 25 JAN 10

      • A is due to Pay EUR 1,000,000 on 05 FEB 10


    Leading and lagging
    Leading and Lagging

    • Speeding Up (Leading) Settlement of Receipt / Payment

    • Slowing Down (Lagging) Settlement of Receipt / Payment

    • Normally on Inter-Company Items:

      • Can Also be on External Items (Risky)


    Leading and lagging1
    Leading and Lagging

    • Useful in Countries with Volatile Rates

    • Some Governments Often Impose Fixed Payment Dates

    • Can also be used for Tax Planning:

    • Shifting Revenues / Costs


    Leading and lagging2
    Leading and Lagging

    • A (Co. in Ruritanian) has to pay 10 m. Ruritanian Pesos (RUP) in one Month

    • Current Spot Rate RUP 10 = GBP 1

    • Current Value GBP 1,000,000

    • Exp. 10% Devaluation of RUP within Month (New Rate RUP 11 = GBP 1)

    • Expected Value GBP 909,090

    • Pay now (Lead) and Save GBP 90,910


    Determining invoice currency
    Determining Invoice Currency

    • Do not Invoice in Weak Currency:

      • Use Strong Currency

      • Prices in Russia Quoted in USD not Russian Roubles (RUR)

  • Could Invoice in Strong Currency to take Advantage of Currency Gains


  • External techniques
    External Techniques

    • Forward Markets

    • Currency Futures Markets

    • Currency Options Markets

    • Currency Swaps

    • Factoring Foreign Debts:

      • Selling Invoice to Factor (Bank)


    Back to exposure
    Back to Exposure

    • A Company only has ONE net Exposure per Currency

    • Treasurer’s Job to Manage this


    Cost control
    Cost Control

    • Use Internal Techniques Whenever Possible:

      • Replace External Techniques

      • Cheaper

      • Offsets Cost of Treasurer

      • Contributes to Profit


    Information flows
    Information Flows

    • Treasurer Needs Information on:

      • Cash Balances:

        • In ALL Currencies

    • Cash Flows Through Trading

    • Cash Requirements for Capital Expenditure


    Information report cycle
    Information Report Cycle

    • Some Information Needed Daily:

      • Cash Balances

      • Cash Expected

      • Cash Required

  • Other Reporting Frequencies:

    • Capital Expenditure Requirements



  • Behavioural issues1
    Behavioural Issues

    • Given Need for:

      • Responsibility

      • Accountability

      • Control

  • How do you Exercise Central Control ?


  • Behavioural issues2
    Behavioural Issues

    • Answer - Persuasion

    • Treasurer’s Rates Always Best

    • Treasurer’s Costs Always Lowest

    • What is in Company’s Interest is also in Subsidiary’s Interest


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