1 / 28

Effective Currency Risk Management Strategies for Foreign Exchange Exposure

In this detailed overview, Gabriel Gigliello, SVP and Sales Manager at Huntington National Bank, discusses various aspects of currency risk management. The presentation covers market updates, types of foreign exchange risk, and methodologies for evaluating risks. Key insights include a comprehensive risk management process, case studies on hedging strategies, and the impact of central bank policies on exchange rates. Firms must actively manage their financial risks to align with their risk tolerance while weighing natural and financial hedging options.

wendi
Télécharger la présentation

Effective Currency Risk Management Strategies for Foreign Exchange Exposure

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. Huntington National Bank Currency Risk Management Managing Foreign Exchange Exposure Gabriel Gigliello SVP, Sales Manager Huntington Bank gabriel.gigliello@huntington.com 800-824-5653 May 19, 2011 1 Capital Markets

  2. Agenda • Market Update • Types of Foreign Exchange Risk • Methods of Evaluating Risk • The Risk Management Process • Case Study: Hedging Strategies 2 Capital Markets

  3. Market Update 3 Capital Markets

  4. Market Update • What’s driving Foreign Exchange rates? • Central Bank forecasts • Inflation readings • Commodity Prices • Risk On/Risk Off • The Federal Reserve and a weaker USD • Quantitative Easing and QE2 • FOMC monetary policy and “extended period” language • Debt issues for Europe in a rising rate environment • PIGS and austerity measures • European Central Bank quandary “inflation or growth” 4 Capital Markets

  5. Market Update • China Appreciation, inflation and growth • US China strategic and economic dialogue • No longer the worlds Low Cost Producer • Increasing Domestic Demand • Emerging markets and imported inflation • Energy prices taking a toll on profits • Central Bank actions • Regional concerns over PBOC actions 5 Capital Markets

  6. Forecast 6 Capital Markets

  7. Exchange Rate Volatility 7 Capital Markets

  8. Types of Foreign Exchange Risk 8 Capital Markets

  9. Risk Management • Financial Risk • The chance for a gain or loss due to price changes in the financial markets. • Financial risks are peripheral to the central business in which companies operate. • Differs from Business Risk, or the chance of incurring a gain/loss as a result of operating a business in a certain industry or environment. • In the context of foreign exchange, financial risk management refers to identifying and measuring the currency risk that a business is exposed to and then balancing it against the company’s appetite for that risk and the tools available for managing that risk. • A firm should actively manage its financial risk to its own level of tolerance – a decision to do nothing is a financial risk decision. 9 Capital Markets

  10. Foreign Exchange Risk • Foreign Exchange Risk: The chance for a gain or loss resulting from changes in exchange rates. • Primarily created by import purchases and export sales • Also created by international (foreign currency denominated) assets and liabilities and by international inter-company transactions such as loans, dividends, royalties, franchise & license fees • Accompanies international acquisitions and divestiture • There are two categories of Foreign Exchange Risk: • Transaction Risk • Translation Risk 10 Capital Markets

  11. Transaction Risk • The US dollar equivalent 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 • Foreign Interest Payments • A cash flow risk • Gains and losses impact income statement 11 Capital Markets

  12. 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 occur 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 a period average exchange rate • A non-cash risk 12 Capital Markets

  13. Natural Hedging Strategies • Businesses may create natural hedges of their currency exposure • Location of plants • Geographic sourcing of inputs • Local currency debt • Key Considerations • Effective for long-term foreign currency exposures and cash flows • Less flexible than financial hedges • Economies of scale, distribution costs, costs of changing • Effective when hedging net investment in foreign operations • Foreign currency debt, or a “short position” created with derivatives 13 Capital Markets

  14. Methods of Evaluating Risk 14 Capital Markets

  15. VaR – the Value-At-Risk Model • VaR is one procedure used for estimating the probability of portfolio losses exceeding some specified proportion based on a statistical analysis of historical market price trends and price volatility. • Volatility is a statistical measure of the tendency of a market or security to rise or fall sharply within a period of time. Volatility is also a variable in option pricing formulas that denotes the extent to which the return of the underlying asset will fluctuate between now and the expiration of the option. • Key Concept: Historical vs. Implied Volatility • Historical Volatility • The past standard deviation of a security that is used in security analysis. Standard deviation measures the changes in the past price of a security the higher the standard deviation the more volatile the security. • The idea behind looking at historical volatility in security analysis is that it provides a measure of the future volatility of the security. For example, if the historical volatility of a security was high, meaning that the price varied a great deal over a period of time, then it might continue this volatility into the future. • Implied Volatility • The estimated volatility of a security’s price over a given time period. • In addition to known factors such as market price, interested rate movement, expiration date, and strike price, implied volatility is used in calculating an option’s premium. IV can be derived from a model such as the Black-Scholes Model. 15 Capital Markets

  16. Market Risk Factors 16 Capital Markets

  17. Implied Volatility 17 Capital Markets

  18. Risk Management Process 18 Capital Markets

  19. Risk Management Process Step 1 Formulate Risk Management Policy Step 2 Identify Exposures Step 3 Determine Budget Rates Step 4 Formulate Hedging Strategies Step 5 Execute Hedging Strategy Step 6 Evaluate Hedge Performance (back to Step 2) 19 Capital Markets

  20. Case StudyHedging a Foreign Acquisition 20 Capital Markets

  21. Case Study – Situation Overview • ABC Industries, a U.S. leading manufacturer of electrical components, recently agreed to acquire their largest competitor in the U.K. – XYZ Electronics. • Under the terms of the deal, ABC will pay 10 million pound sterling (GBP) in cash to acquire XYZ. ABC has budgeted a purchase price of $17,000,000 million. • The acquisition is expected to close in two months subject to due diligence. 21 Capital Markets

  22. Case Study – ABC’s Objectives • Guaranteed protection. Establish a known worst-case USD cost for acquiring XYZ. • Cost-effective. Minimize up-front costs to hedge acquisition. • Upside potential. Retain ability to benefit if the GBP subsequently weakens against the USD. • Minimize breakage costs. Minimize potential liability in the event acquisition does not go through and hedges must be unwound. • Simplicity. Must be easy to explain to board and senior management. 22 Capital Markets

  23. Case Study – Hedging Strategies • Currency Option Establishes a Known Worst-Case Rate But Retains Upside Potential • ABC can enter into a collar to establish a worst-case (cap) and best-case (floor) exchange rate for purchasing GBP. • Collar can be as wide or as narrow as you wish depending on your risk tolerance. • Collar usually will be centered around current forward rate. • Can be structured with no up-front fee. • Protects against any strengthening of the GBP above the cap rate. • You retain upside potential associated with a weakening of the GBP down to the floor rate. 23 Capital Markets

  24. Case Study – Summary of Hedging Alternatives 24 Capital Markets

  25. Case Study – Indicative Pricing Strategy: Forward 1.6360 1.6348 GBP Call / USD Put $240,000 1.6675 GBP Call / USD Put $107,000 Zero-cost collar 1.6530-1.6110 25 Capital Markets

  26. Case Study - Graph 26 Capital Markets

  27. Case Study - Outcome • ABC entered into a collar option • Limited liability 27 Capital Markets

  28. Foreign Exchange Contracts 28 Capital Markets

More Related