Title: F/X Exposure
1More Winter ahead
2Trade, FDI, and the Economy
Cash
T-bills, assets
- U.S. trade deficit offset by capital surplus
- U.S. attracts FDI reduces U.S. imports
3Foreign Currency
- What is it?
- Why does it change?
- Risk for international managers
- How to manage risk
4Linkage Between Currencies
World Market for Euros
World Market for Dollars
Price /
Price /
S
S
.77 /
1.30 /
D
D
Same marketdifferent perspective.
5Trade, FDI, and the Economy
Computers
Cash
- Increase demand for Japanese computers trade
deficit - Increase demand for computer inputs (components,
labor, etc.) inflationary - Increase demand for Yen appreciates
- Stronger Yen increases U.S. prices decreases
demand for Japanese computers
6German Market for BMWs
S
Price in Euros
100,000
D
7Global Market for BMWsAmericans want to import
BMWs
S
Price in Euros
110,000
100,000
D
D
8World Market for Euros
S
Price in Dollars
0.77 /
D
9World Market for D-MarksAmericans need to
convert Dollars to Euros
Price /
S
0.74 /
0.77 /
D
D
10Linkage Between Currencies
World Market for Euros
World Market for Dollars
Price /
Price /
S
S
0.77/
1.30/
D
D
11Linkage Between Currencies
World Market for Euros
World Market for Dollars
Price /
Price /
S
S
S
0.74/
1.30/
0.77/
1.35/
D
D
D
12Other Forces Causing Change
- Foreign Direct Investment
- Foreign Portfolio Investment
- MNCs
- Government Debt Instruments
- Currency Arbitrage and Speculation
- Governmental Intervention
- Official and Unofficial pegs
- International Agreements (e.g., G-7, the Euro)
- Posturing (e.g., talking the dollar down)
13Index of Swiss Franc vs. Dollar1990 100
2000
1990
1980
14Depreciating Peso
15The Big Mac Index
www.economist.com
16Short-term F/X Management
- Currency Hedges
- Forward Contracts
- Options
- Negotiation of Ratcheted Pricing Schedule
- Adjustment of Prices and Target Profits
- Lower foreign prices to keep market share when
home currency appreciates lowers profit margin - Raise foreign prices to keep profit margins when
home currency depreciates less price
competitive
17Today US Dealer to Import BMWs
- Sales Contract
- Quantity 100 BMW 750s
- Price 100,000 each
- Payment Due in 3 months
- Value of Sales Contract
- 10.0 million
- Spot Rate 1.30 /
- 13.0 million
18In Three Months Payment is DueUncovered
Transaction
- Euro appreciates
- New spot rate 1.35 /
- 10.0 million
- Adjusted Value of Sales Contract
- Risk penalty 0.05 per traded
- 13.5 million
- US Dealers Loss 500,000
19Today US Dealer to Import BMWsHedged Transaction
- Sales Contract
- Quantity 100 BMW 535s
- Price 100,000 each
- Payment Due in 3 months
- Value of Sales Contract
- 10 million
- at 90-day Forward Rate 1.305 /
- Insurance premium 0.005 per traded
- 13.05 million
20In Three Months Payment is Due Hedged
Transaction
- Euro appreciates
- New spot rate 1.35 / (Doesnt matter!!!)
- 10 million
- Adjusted Value of Sales Contract
- Locked-in Forward Rate 1.305 /
- 13.05 million
- Cost of Hedge (insurance premium) 50,000
21In Three Months Payment is Due Hedged
Transaction
- Euro Depreciates
- New spot rate 1.25 /
- 10 million
- Adjusted Value of Sales Contract
- Locked-in Forward Rate 1.305 / (Spot
better!!) - 12.5 million
- Currency Windfall - Cost of Hedge 450,000
22Medium-Term F/X Management
- Balance sheet hedge
- Match foreign assets with same level of foreign
liabilities in same currency - Cash flow hedge
- Match foreign A/P with A/R in same currency
23Long-Term F/X Management
- Shift sourcing and procurement
- Shift production
- Cut costs / improve productivity