Transaction Risk

1
Transaction Risk

• Identify Current Receivables and Payables
• Evaluate how likely fx changes will affect
  home country values of the receivables and
  payables
• Assess least -cost method of hedging
• Choose whether and how much to hedge

2
Hedging Transaction Risk

• Tools
• Forward purchase or sale
• Money Market Swap
• Forward swap
• Leads-lags
• Cost of Hedge
• Forward premium (buy)
• Forward discount (sell)
• Interest rate differential (swap and leads-lags)

3
Translation Risk

• Identify net worth position of different
  affiliates
• Evaluate how likely changes in fx values will
  affect the net worth positions of the affiliates
• Assess whether fx changes anticipated are likely
  to be short or log run
• Assess least cost method of hedging- then choose
  strategy.

4
Hedging Translation Risk

• Tools
• Sell assets
• Assume long-run liabilities
• Invest in offsetting long-term assets
• Long-run swaps
• Costs
• Interest rate differentials
• Transactions costs
• Reduced efficiency/effectiveness

5
Economic Risk (Operating Risk)

• Identify how revenue stream will be impacted by
  fx changes over time
• Competitive ability to raise or maintain prices
• Competitive ability to sustain unit sales at
  current prices
• Identify how costs will be impacted by fx changes
  over time
• Price of imported inputs in home currency
• Prices of domestic inputs

6
Issues In Estimating Economic Risk

• Focus is on the long-run competitive position of
  the firm
• Transaction risk is a potentially small component
  of economic risk
• Indirect impacts can be more important than
  direct impacts
• Firms in different industries can be
  differentially affected by same exchange rate
  changes

7
Tools For Managing Economic Risk

• Relocate operating units to lower cost regions
• Emphasize price insensitive products in product
  portfolio
• Lock-in long-run prices for inputs
• Hedge long-date receivables and payables

8
Short-Case Toronto Raptors

• Bulk of costs are salaries to players paid in
  U.S. dollars
• Bulk of revenues are gate receipts denominated in
  Canadian dollars
• Also, receipts from local TV and radio
  broadcasting rights (in Canadian dollars)
• Question What concerns would this situation
  raise for you as Raptors management and what
  would you do?

9
Longer Case Trizec Hahn

• Discuss what sorts of FX risk you would be
  concerned about if you were a Trizec manager
• Discuss how you would assess the severity of the
  risks identified
• Discuss how you might address the risks
  identified.