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1、Copyright 2009 Pearson Prentice Hall. All rights reserved.Chapter 9Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction Exp
2、osureLearning ObjectivesDistinguish between the three major foreign exchange exposures experienced by firmsAnalyze the pros and cons of hedging foreign exchange transaction exposureIdentify foreign exchange transaction exposureIdentify the alternatives available to a firm for managing a large and si
3、gnificant transaction exposure9-2Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureForeign exchange exposur
4、e is a measure of the potential for a firms profitability, net cash flow, and market value to change because of a change in exchange ratesThe profits, cash flow and market value are the key financial elements of how we view the relative success or failure of a firmTypes of foreign exchange exposureT
5、ransaction Exposure measures changes in the value of outstanding financial obligations incurred prior to a change in exchange rates but not due to be settled until after the exchange rate changesOperating Exposure also called economic exposure, measures the change in the present value of the firm re
6、sulting from any change in expected future operating cash flows cTranslation Exposure also called accounting exposure, is the potential for accounting derived changes in owners equity to occur because of the need to “translate” financial statements of foreign subsidiaries into a single reporting cur
7、rency for consolidated financial statements caused by an unexpected change in exchange rates9-3Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transac
8、tion ExposureExhibit 9.1 Conceptual Comparison of Transaction, Operating, and Translation Foreign Exchange Exposure9-4Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn ex
9、ample: Tridents Transaction ExposureMeasurement of Transaction ExposureTransaction exposure measures gains or losses that arise from the settlement of existing financial obligations. 9-5Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForei
10、gn Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction Exposure1) _ exposure deals with cash flows that result from existing contractual obligations. A) Operating B) Transaction C) Translation D) Economic Answer: B 9-6Foreign Exchange ExposureTransaction Expo
11、sure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureMeasurement of Transaction ExposureTransaction exposure:Purchasing or selling on credit goods or services when prices are s
12、tated in foreign currenciesBorrowing or lending funds when repayment is to be made in a foreign currencyBeing a party to an unperformed forward contract and Otherwise acquiring assets or incurring liabilities denominated in foreign currencies9-7Foreign Exchange ExposureTransaction Exposure and Hedgi
13、ng TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTransaction Exposure: Purchasing or Selling on Open AccountSuppose Trident Corporation sells merchandise on open account to a Belgian buy
14、er for 1,800,000 payable in 60 daysFurther assume that the spot rate is $1.2000/ and Trident expects to exchange the euros for 1,800,000 x $1.2000/ = $2,160,000 when payment is receivedTransaction exposure arises because of the risk that Trident will something other than $2,160,000 expectedIf the eu
15、ro weakens to $.1000/, then Trident will receive $1,980,000If the euro strengthens to $1.3000/, then Trident will receive $2,340,0009-8Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedgin
16、g TechniquesAn example: Tridents Transaction ExposureExhibit 9.3 The Life Span of a Transaction Exposure9-9Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Trid
17、ents Transaction ExposureHedging Transaction ExposureTransaction exposure can be managed by contractual and natural hedge.A natural hedge is one that results from matching foreign currency cash flows that come about from the normal operations of a MNE. An example would be for a MNE that had euro ope
18、rating inflows from sales to borrow an equivalent amount of euros to finance working capital.A contractual hedge is a contract specifically entered into as a financial rather than operating hedge.Examples are forward and future foreign exchange agreements, money market hedges, and purchase of option
19、s.9-10Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureContractual Hedging TechniqueslHedging of ReceivablesSell futures or forward
20、 Money market hedgeborrow foreign currency to be receivedconvert to domestic currencyinvest for future useBuy Put Option lHedging of PayablesBuy futures or forward Money market hedgeborrow home currencyconvert to foreign currencyinvest for future useBuy Call Option 9-11Foreign Exchange ExposureTrans
21、action Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction Exposure6) Losses from _ exposure generally reduce taxable income in the year they are realized. _ exposure losses may r
22、educe taxes over a series of years. A) accounting; Operating B) operating; Transaction C) transaction; Operating D) transaction; Accounting Answer: C 9-12Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction
23、Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureMaria Gonzalez, CFO of Trident, has just concluded a sale to Regency, a British firm, for 1,000,000The sale is made in March for settlement due in three months time, JuneAssumptionsSpot rate is $1.76
24、40/3 month forward rate is $1.7540/ (a 2.2676% discount)Interest rate:UK 3 month borrowing rate is 10.0% p.a.UK 3 month investing rate is 8.0% p.a. Tridents cost of capital is 12.0%US 3 month borrowing rate is 8.0% p.a.US 3 month investing rate is 6.0% p.a.June put option in OTC market for 1,000,000
25、; strike price $1.75; 1.5% premiumTridents foreign exchange advisory service forecasts future spot rate in 3 months to be $1.7600/Trident operates on thin margins and Maria wants to secure the most amount of US dollars; her budget rate (lowest acceptable amount) is $1.7000/9-13Foreign Exchange Expos
26、ureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureTrident might have avoided transaction exposure by invoicing the Belgian bu
27、yer in US dollars, but this might have lead to Trident not being able to book the saleMaria faces four possibilities:Remain unhedgedHedge in the forward marketHedge in the money marketHedge in the options market9-14Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tride
28、nts Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction Exposure: Unhedged positionUnhedged positionMaria may decide to accept the transaction riskIf she believes that the future spot rate will be $1.76
29、/, then Trident will receive 1,000,000 x $1.76/ = $1,760,000 in 3 months timeHowever, if the future spot rate is $1.65/, Trident will receive only $1,650,000 well below the budget rate9-15Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureFor
30、eign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureForward Market hedgeA forward hedge involves a forward or futures contract and a source of funds to fulfill the contractThe forward contract is entered at the time t
31、he A/R is created, in this case in MarchWhen this sale is booked, it is recorded at the spot rate. In this case the A/R is recorded at a spot rate of $1.7640/, thus $1,764,000 is recorded as a sale for TridentIf Trident does not have an offsetting A/P in the same amount, then the firm is considered
32、uncovered9-16Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureForward Market hedgeShould Maria want to
33、 cover this exposure with a forward contract, then she will sell 1,000,000 forward today at the 3 month rate of $1.7540/She is now “covered” and Trident no longer has any transaction exposureIn 3 months, Trident will received 1,000,000 and exchange those pounds at $1.7540/ receiving $1,754,000This s
34、um is $6,000 less than the uncertain $1,760,000 expected from the unhedged positionThis would be recorded in Tridents books as a foreign exchange loss of $10,000 ($1,764,000 as booked, $1,754,000 as settled)9-17Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents
35、Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureMoney Market hedgeTo hedge in the money market, Maria will borrow pounds in London, convert the pounds to dollars and repay the pound loan wit
36、h the proceeds from the saleTo calculate how much to borrow, Maria needs to discount the PV of the 1,000,000 to today1,000,000/1.025 = 975,610Maria should borrow 975,610 today and in 3 months time repay this amount plus 24,390 in interest (1,000,000) from the proceeds of the sale9-18Foreign Exchange
37、 ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureMoney Market hedgeTrident would exchange the 975,610 at the spot rate
38、 of $1.7640/ and receive $1,720,976 at onceThis hedge creates a pound denominated liability that is offset with a pound denominated asset thus creating a balance sheet hedge Account receivable1,000,0001,000,000Bank loan (principal) 975,610Interest payable 24,3901,000,000Assets Liabilities and Net Wo
39、rth9-19Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureIn order to compare the forward hedge with the
40、 money market hedge, Maria must analyze the use of the loan proceedsRemember that the loan proceeds may be used today, but the funds for the forward contract may notBecause the funds are relatively certain, comparison is possible in order to make a decisionThree logical choices exist for an assumed
41、investment rate for the next 3 months9-20Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureFirst, if Tr
42、ident is cash rich the loan proceeds might be invested at the US rate of 6.0% p.a.Second, Maria could use the loan proceeds to substitute an equal dollar loan that Trident would have otherwise taken for working capital needs at a rate of 8.0% p.a.Third, Maria might invest the loan proceeds in the fi
43、rm itself in which case the cost of capital is 12.0% p.a.Received todayInvested inRateFuture value in 3 months$1,720,976Treasury bill6% p.a. or 1.5%/quarter$1,746,791$1,720,976Debt cost8% p.a. or 2.0%/quarter$1,755,396$1,720,976Cost of capital12% p.a. or 3.0%/quarter$1,772,6059-21Foreign Exchange Ex
44、posureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureBecause the proceeds in 3 months from the forward hedge will be $1,754,0
45、00, the money market hedge is superior to the forward hedge if Maria used the proceeds to replace a dollar loan (8%) or conduct general business operations (12%)The forward hedge would be preferable if Maria were to just invest the loan proceeds (6%)We will assume she uses the cost of capital as the
46、 reinvestment rate9-22Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureA breakeven investment rate can
47、 be calculated in order to forgo numerous calculations and still aid Maria in her decisionTo convert this 3 month rate to an annual rate, 9-23Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and
48、 Hedging TechniquesAn example: Tridents Transaction ExposureTridents Transaction ExposureIn other words, if Maria can invest the loan proceeds at a rate equal to or greater than 7.68% p.a. then the money market hedge will be superior to the forward hedgeThe following chart shows the value of Trident
49、s A/R over a range of possible spot rates both uncovered and covered using the previously mentioned alternatives9-24Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn exam
50、ple: Tridents Transaction ExposureExhibit 9.4 Valuation of Cash Flows by Hedging Alternative for Trident9-25Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tri
51、dents Transaction ExposureTridents Transaction ExposureOption market hedgeMaria could also cover the 1,000,000 exposure by purchasing a put option. This allows her to speculate on the upside potential for appreciation of the pound while limiting her downside riskGiven the quote earlier, Maria could
52、purchase 3 month put option at an ATM strike price of $1.75/ and a premium of 1.5%The cost of this option would be9-26Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn ex
53、ample: Tridents Transaction ExposureTridents Transaction ExposureBecause we are using future value to compare the various hedging alternatives, it is necessary to project the cost of the option in 3 months forwardUsing a cost of capital of 12% p.a. or 3.0% per quarter, the premium cost of the option
54、 as of June would be$26,460 1.03 = $27,254Since the upside potential is unlimited, Trident would not exercise its option at any rate above $1.75/ and would sell pounds on the spot marketIf for example, the spot rate of $1.76/ materializes, Trident would exchange pounds on the spot market to receive
55、1,000,000 $1.76/ = $1,760,000 less the premium of the option ($27,254) netting $1,732,746 9-27Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transact
56、ion ExposureTridents Transaction ExposureUnlike the unhedged alternative, Maria has limited downside with the optionShould the pound depreciate below $1.75/, Maria would exercise her option and exchange her 1,000,000 at $1.75/ receiving $1,750,000Less the premium of the option, Maria nets $1,722,746
57、Although this downside is less than that of the forward or money market hedge, the upside potential is not limited9-28Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn ex
58、ample: Tridents Transaction ExposureTridents Transaction ExposureAs with the forward and money market hedges, Maria can also calculate her breakeven price on the optionThe upper bound of the range is determined by comparison of the forward rateThe pound must appreciate above $1.754/ forward rate plu
59、s the cost of the option, $0.0273/, to $1.7813/The lower bound of the range is determined in a similar mannerIf the pound depreciates below $1.75/, the net proceeds would be $1.75/ less the cost of $0.0273/ or $1.722/9-29Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example:
60、 Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureExhibit 9.5 Tridents Hedging Alternatives, Including an ATM Put Option9-30Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Trident
61、s Transaction ExposureTridents Transaction ExposurePut Option Strike PriceATM Option $1.75/Option cost (future cost)$27,254Proceeds if exercised $1,750,000Minimum net proceeds $1,722,746Maximum net proceeds unlimitedBreakeven spot rate (upside) $1.7813/Breakeven spot rate (downside) $1.7221/9-31教育育人
62、Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureStrategy Choice and OutcomeTrident, like all firms, must decide on a strategy to u
63、ndertake before the exchange rate changes but how will Maria choose among the strategies?Two criteria can be utilized to help Maria choose her strategyRisk tolerance - of the firm,as expressed in its stated policies andViewpoint Marias own view on the expected direction and distance of the exchange
64、rateFinancial situation9-32Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureStrategy Choice and OutcomeAfter all the strategies hav
65、e been explained, Trident now needs to compare the alternatives and their outcomes in order to choose a strategyThere were four alternatives available to manage this account receivable and Maria has a budget rate at which she cannot fall below on this transaction9-33Foreign Exchange ExposureTransact
66、ion Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureStrategy Choice and OutcomeHedging Strategy Outcome/PayoutRemain uncoveredUnknownForward Contract hedge $1.754/$1,754,000Money market hedge 8% p.a.$1,755,396Money market hedge 12% p.a.$1,772,605Put option hedge strike $1.75/
67、Minimum if exercised$1,722,746Maximum if not exercisedUnlimited9-34教育育人Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureRisk Manage
68、ment in PracticeWhich Contractual Hedges?Transaction exposure management programs are generally divided along an “option-line;” those which use options and those that do notAlso, these programs vary in the amount of risk covered; these proportional hedges are policies that state which proportion and
69、 type of exposure is to be hedged by the treasury9-35Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureWhy Hedge - the Pros & ConsHe
70、dging protects the owner of an asset (future stream of cash flows) from lossHowever, it also eliminates any gain from an increase in the value of the asset hedged againstDiscussion: if you are the owner of an MNE, would you like the management to hedge foreign exchange exposure?9-36Foreign Exchange
71、ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureWhy Hedge - the Pros & ConsOpponents :Shareholders are more capable of diversifying risk than the m
72、anagement of a firm; Currency risk management does not increase the expected cash flows of a firm; currency risk management normally consumes resources thus reducing cash flowManagement often conducts hedging activities that benefit management at the expense of shareholdersManagers cannot outguess t
73、he market; if and when markets are in equilibrium with respect to parity conditions, the expected NPV of hedging is zero9-37Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging Technique
74、sAn example: Tridents Transaction ExposureWhy Hedge - the Pros & ConsProponents :Reduction in risk in future cash flows improves the planning capability of the firmReduction of risk in future cash flows reduces the likelihood that the firms cash flows will fall below a necessary minimumManagement ha
75、s a comparative advantage over the individual investor in knowing the actual currency risk of the firmMarkets are usually in disequilibirum because of structural and institutional imperfections9-38Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction Ex
76、posureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureSummary of Learning ObjectivesMNEs encounter three types of currency exposure: (1) transaction; (2) operating; and (3) translation exposureTransaction exposure arises from (1) purchasin
77、g or selling on credit and prices are stated in foreign currencies; (2) borrowing or lending funds when repayment is to be made in a foreign currency; (3) being party to an unperformed forward contract; and (4) otherwise acquiring assets or liabilities denominated in foreign currencies9-39Foreign Ex
78、change ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureSummary of Learning ObjectivesTransaction exposure can be managed by contractual techniques
79、and certain operating strategies. Contractual techniques include forward contracts, money market and option hedgesThe choice of which hedge to use depends on the individual firms currency risk tolerance and its expectations of the probable movement of exchange rates over the transaction exposure per
80、iod9-40Foreign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureForeign Exchange ExposureTransaction Exposure and Hedging TechniquesAn example: Tridents Transaction ExposureSummary of Learning ObjectivesIn general, if an exchange rate is expected t
81、o move in a firms favor, the preferred contractual hedges are those which allow the firm to participate in some of the upside potential, but protect it against adverse exchange rate movementsIn general, if an exchange rate is expected to move against the firm, the preferred contractual hedge is one which locks-in an exchange rate9-41
