1 / 31

Chapter 10 Managing Transaction Exposure to Currency Risk

Exposures to currency risk. . Change in firm value due to unexpected changes in foreign exchange ratesTransaction exposurechange in the value of contractual cash flows arising from the firm's monetary assets and liabilitiesOperating exposurechange in the value of noncontractual cash flows a

fedella
Download Presentation

Chapter 10 Managing Transaction Exposure to Currency Risk

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


    1. Chapter 10 Managing Transaction Exposure to Currency Risk

    2. Exposures to currency risk

    3. A forward currency hedge Underlying pound exposure Short Ł forward position Net position Net exposure

    4. Managing transaction exposure Managing transaction exposure internally multinational netting (currency diversification) leading and lagging Managing transaction exposure in the financial markets currency forwards money market hedges futures options swaps

    5. Multinational netting

    6. Cash flows before netting

    7. Cash flows after netting

    8. Leading and lagging Leading and lagging refers to altering the timing of cash flows within the firm to offset foreign exchange exposures For example: Leading - If a parent firm is short euros, it can accelerate euro payments from its subsidiaries Lagging - If a parent firm is long euros, it can delay euro payments from its subsidiaries

    9. Leading and lagging

    10. Currency forward contracts Advantages Forwards can provide a perfect hedge of transactions of known size and timing Disadvantages Bid-ask spreads can be large on small transactions, long-dated contracts, or infrequently traded currencies Forwards are a pure credit instrument, so forward contracts have credit risk

    11. Currency futures contracts The futures contract solution to the default risk of forward contracts An exchange clearinghouse takes one side of every transaction Futures contracts are marked-to-market on a daily basis Initial and maintenance margins are required on futures contracts

    12. FX forwards versus futures contracts Forwards Futures Counterparty Bank Futures exchange clearinghouse Maturity Negotiated Standardized Amount Negotiated Standardized Fees Bid-ask Commissions Collateral Negotiated Margin account

    13. Currency futures contracts Advantages Low cost if the size, currency and maturity match the underlying exposure Low credit risk with daily marking-to-market Disadvantages Costs increase with transaction size Exchange-traded futures come in limited currencies and maturities Daily marking-to-market can cause a cash flow mismatch

    14. Money market hedges Advantages Synthetic forward positions can be built in currencies for which there are no forward currency markets Disadvantages Relatively expensive hedge Might not be feasible if there are constraints on borrowing or lending

    15. Currency option hedges Advantages Disaster hedge insures against unfavorable currency movements Disadvantages Option premiums reflect option values, so option hedges can be expensive in volatile currencies and at distant expiration dates

    16. A pound call is an option to buy pounds the option holder gains if pound sterling rises the option holder does not lose if pound falls A currency call option

    17. A call option hedge

    18. A call option hedge

    19. A call option hedge

    20. A pound put is an option to sell pounds the option holder gains if pound sterling falls the option holder does not lose if pound rises A currency put option

    21. A put option hedge

    22. A put option hedge

    23. A put option hedge

    24. Currency swaps… “I’ll pay yours if you pay mine” Currency swap An agreement to exchange a principal amount of two currencies and, after a pre-arranged length of time, re-exchange the original principal Interest payments are also usually swapped during the life of the contract

    25. Currency swap contracts Advantages Quickly transforms the firm’s liabilities into other currencies or payout structures Low cost for plain vanilla swaps in actively traded currencies Swaps can be used to to hedge long-term exposures Disadvantages Not the best choice for near-term exposures Innovative or exotic swaps can be expensive

    26. Financial market hedges Vehicles Advantages Disadvantages Forward Exact hedge; Large bid-ask spreads on Small bid-ask spread small or long-dated deals & for large deals thinly traded currencies Future Low cost for small Only a few currencies & deals; low risk maturities; mark-to-market with mark-to-market can cause a CF mismatch Money market Synthetic forward Relatively expensive; not hedge always possible Swap Quick & low-cost Innovative swaps costly; switch of payoff may not be best for structures near-term exposures Option Disaster hedge Option premiums provides insurance can be expensive

    27. Active management of fx risk Bodnar, Hayt, and Marston, “1998 Wharton Survey of Derivatives Usage by U.S. Non-Financial Firms,” Financial Management (1998).

    28. Risk management benchmarks Bodnar, Hayt, and Marston, “1998 Wharton Survey.”

    29. Performance evaluation Bodnar, Hayt, and Marston, “1998 Wharton Survey.”

    30. Active treasuries Tend to be large firms with centralized risk management Use sophisticated valuation methodologies such as value-at-risk for managing their exposures Frequently mark their derivatives positions to market Géczy, Minton, and Schrand, “Taking a View: Corporate Speculation, Governance, and Compensation” Journal of Finance (2007)

    31. Active treasuries manage their managers Managers’ actions are closely monitored Firms use compensation contracts to align managers’ objectives with those of other stakeholders Firms use derivatives-specific controls such as performance benchmarks to manage potential abuses Géczy, Minton, and Schrand, “Taking a View”

    32. Corporate use of derivatives Used Total Type of product often usage Currency forwards 72.3% 93.1% Currency swaps 16.4 52.6 OTC currency options 18.8 48.8 Cylinder options 7.0 28.7 Synthetic forwards 3.0 22.0 Currency futures 4.1 20.1 Exchange-traded (spot) options 3.6 17.3 Exchange-traded futures options 1.8 8.9 Jesswein, Kwok & Folks, “What New Currency Risk Products Are Companies Using and Why?” Journal of Applied Corporate Finance (1995)

More Related