Avoiding Risky Business:FX Hedging Best PracticesEd Sauve & Joe O’LearyMay 26, 2011
Today’s Speakers• Ed Sauve, Senior Foreign Exchange Advisor, Silicon Valley Bank• Joe O’Leary, Senior Foreign Exchange Tra...
Topics for Today• Globalization, Foreign Exchange and Your Company• Perceptions and Reality• Best Practices• Common Hedgin...
Globalization, Foreign Exchangeand Your CompanyEd SauveSenior Foreign Exchange Advisor,Silicon Valley Bank                ...
Global ExpansionForeign exchange-Foreign currency impact unavoidable  •   Impact even if all business is conducted in USD ...
Foreign Exchange Market• Massive: Dwarfs all exchanges• Global• 24x7• Unregulated freely floating currencies• Volatility• ...
Foreign Exchange and the EnterpriseTreasury operations •   Pay overseas vendors and/or employees •   Invest capital & fund...
Foreign Exchange Risk• Foreign exchange rates fluctuate continuously –volatility• FX gains or losses unless every current ...
Foreign Currency Cash Flow #1 andRelated Foreign Currency Exposure                                EUR 1,500,000           ...
Foreign Currency Cash Flows #2                                                                    Clinical Trials in      ...
Foreign Currency Cash Flows #3                                                                      European              ...
Foreign Currency Cash Flows #4 (and itcan get even more complicated)                                                      ...
Hedging StrategiesJoe O’LearySenior Foreign Exchange Trader,Silicon Valley Bank                                  13
Definition of Foreign Exchange Hedging• “We use financial instruments to mitigate exposure”• “Entails giving up some oppor...
Market Forecasts vs. Reality  ■ Predicted ■ Actual  Source: Reuters                               15
Risk Curve Analysis –   Standard Deviation                            EUR/USD  1.55                        EUR/USD        ...
Common Misconceptions                        17
Misconception: Hedging is a Form of SpeculationReality• Not hedging is actually a form of speculation• Hedging is another ...
Misconception: Foreign Exchange MovementsEven Out Over TimeReality• What is your time horizon?  Source: Bloomberg         ...
Misconception: A Company is Immune toForeign Currency DynamicsReality• Pricing and reporting in USD does not mitigate curr...
Misconception: Too Time Consuming • Average time spent on the programs was 3 hours a month • 4 hours at quarter end • Most...
Getting Started                  22
When to Consider FX Hedging• Selling overseas• Buying from overseas suppliers• Setting up manufacturing facilities oversea...
Getting StartedANALYSIS     DEVELOP FX POLICY   CHOOSE STRATEGY   MONITOR EVENTS                                 AND EXECU...
AnalysisData collection to identify global exposure•   Forecasted sales, purchases, profits, dividends•   Firm commitments...
Strategic Approach to RiskHIGH                                                  Fully Hedged  PROBABILITY                 ...
Develop a Foreign Exchange PolicyFX Policy• A framework approved by the board  that incorporates all aspects of FX risk  m...
Develop a Foreign Exchange Policy – cont.Policy Components•   Objectives•   Risk tolerance-Passive? Active?•   Hedging str...
Choosing the Right Strategy and ExecutingCommon Hedging Instruments• Natural offset- Currency accounts• Forward contracts•...
Monitor Events and Results• Ensure exposures are being hedged as planned• Develop regular reports to evaluate success of h...
Common Hedging PracticesAssociation of Corporate Treasurers• 90% centralized hedge management• 80% hedge cash forecasts (A...
Common Hedging Strategies                            32
Natural Offset• Easier and less time consuming• Utilizing non- USD accounts to collect and pay in same currency• Allows fo...
“No Free Lunch”             Flexibility/Upfront costs   Least                                   Most  Forwards            ...
Forwards/Window Forward• Contractual agreement that your foreign currency payment or collection, scheduled to take place o...
Forward Contract- Example                                                            EUR 1,500,000                        ...
Plain Option• An Option gives the buyer the right, but not the obligation to fulfill the option at maturity• The premium i...
Option Example                                                            EUR 1,500,000                                   ...
Financial Reform Update – Issued May 2012• Treasury Notice of “Proposed Determination on Foreign Exchange Forwards and  Sw...
Questions?             40
Contacts           41
Ed Sauve                                  Ed Sauve is the senior advisor for the Global Financial Services Group          ...
Joe O’Leary                                  Joe OLeary has over 14 years of experience working in the financial services ...
AdvisorsWest                           West                Central                 EastDave Bhagat                    Mary...
SVB’s Foreign Exchange DeskToll Free: 888.313.4029FXTraders@svb.com                              45
DisclosuresForeign exchange transactions can be highly risky, and losses may occur in short periodsof time if there is an ...
Avoiding Risky Business: FX Hedging Best Practices
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Avoiding Risky Business: FX Hedging Best Practices

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Hedging is an important defensive move for your company and, if used effectively, can be a valuable offensive strategy as well. This presentation addresses how, by hedging, or actively managing your company's foreign exchange exposure to protect revenues, expenses, assets and liabilities from exchange rate volatility, you can minimize disruption to the business and improve the bottom line.

Topics include:
- Various types of currency risks
- Why you need to manage FX risk — and when?
- How to select the best strategy for your company
- How to hedge internally
- When to employ FX tools including spot contracts, forward contracts, over-the-counter options, structured strategies and foreign currency deposits

Speakers:
- Joe O'Leary - Senior Foreign Exchange Trader, Silicon Valley Bank
- Ed Sauve - Senior Advisor, Global Financial Services, Silicon Valley Bank

Published in: Economy & Finance
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Avoiding Risky Business: FX Hedging Best Practices

  1. 1. Avoiding Risky Business:FX Hedging Best PracticesEd Sauve & Joe O’LearyMay 26, 2011
  2. 2. Today’s Speakers• Ed Sauve, Senior Foreign Exchange Advisor, Silicon Valley Bank• Joe O’Leary, Senior Foreign Exchange Trader, Silicon Valley Bank 2
  3. 3. Topics for Today• Globalization, Foreign Exchange and Your Company• Perceptions and Reality• Best Practices• Common Hedging Instruments• Regulatory Update• Q&A 3
  4. 4. Globalization, Foreign Exchangeand Your CompanyEd SauveSenior Foreign Exchange Advisor,Silicon Valley Bank 4
  5. 5. Global ExpansionForeign exchange-Foreign currency impact unavoidable • Impact even if all business is conducted in USD • Rate of exchange between two currencies is not fixed • Volatility of exchange rates: 5/4/11 - $1.4827 = EUR 1.0000 5/6/11 - $1.4316 = EUR 1.0000 =3.5% value change in 2 day 5
  6. 6. Foreign Exchange Market• Massive: Dwarfs all exchanges• Global• 24x7• Unregulated freely floating currencies• Volatility• Not uniform (e.g. restricted)• Wholesale market & market makers vs. small bus./retail• Bid-ask quotes based on spot market e.g. bid $1.4750; Ask $1.4755 to purchase 1 euro (EUR). 2 day settlement• Duality-currency pairs (EUR/USD; USD/JPY) 6
  7. 7. Foreign Exchange and the EnterpriseTreasury operations • Pay overseas vendors and/or employees • Invest capital & fund foreign operations • Channel sales proceeds (A/R) denominated in foreign currencies • Receive dividends, funded debt, & return capital denominated in foreign currency Strategic transactions Reliable and timely execution is critical 7
  8. 8. Foreign Exchange Risk• Foreign exchange rates fluctuate continuously –volatility• FX gains or losses unless every current and future FX exposure is perfectly offset in terms of amount and settlement date• Key factors = Amount, direction & maturity/settlement• Types of risk: o Transaction-Exposure based on identified funds flow such as foreign currency receipts or payments o Translation-Exposure from foreign currency denominated assets, liabilities, and capital o Economic-Long term Impact of exchange volatility e.g. pricing in USD versus competition in local currency 8
  9. 9. Foreign Currency Cash Flow #1 andRelated Foreign Currency Exposure EUR 1,500,000 Sold on 60 day terms. P.O. received 30 days before shipment Medical Device One Time Large Systems Company Order from Selling to USA Regional Hospital customer base Group in Europe EUR 1,500,000 Sales Proceeds due 60 days after invoice Upon receipt of firm Purchase Order the Med Device Company is “long” EUR for 90 days and is “exposed” to the risk of fluctuations reducing USD proceeds on the day the buyer pays the EUR 1.5 million. 9
  10. 10. Foreign Currency Cash Flows #2 Clinical Trials in EUR Germany 100,000/ Month EUR Early Stage Life 25,000/ Pre-Clinical Trials Science Company Month in France Pre-Revenue Well Funded & GBP Product(s) in 35,000/Month Development Research expense At Current Rates Company can be said in UK to be: •“Short” EUR 125,000 per month = to $180,000 or $2.16 million for the year at $1.44 = EUR 1.00 •Also “short” GBP 35K/month = to $57,050 or $684,600 for the year 10
  11. 11. Foreign Currency Cash Flows #3 European Distributor EUR (On continent) 125,000/ Growing Month Electronics Company Large Japanese US Dollar Expense JPY 75 Corporate Mio/ Month Customer Base But Overseas Demand and need GBP to Sell in Local 50,000/Month UK Sales Currencies Subsidiary At Current Rates Company is: •“Long” EUR 125,000 per month = to $180,000 or $2.16 million for the year at $1.44 = EUR 1.00 •Also “Long” JPY 75 million per month = to $937,500/Mo or $11,250,000 •Also “short” GBP 35K/month = to $57,050 or $684,600 for the year 11
  12. 12. Foreign Currency Cash Flows #4 (and itcan get even more complicated) Dutch Based Customers in Exp =EUR 125,000/ month European HQ and Germany Sales subsidiary EUR EUR Sales =2,000,000 Exp Customers in per month CAD 100,000 France Major Software per month Canadian Company with Customers in Customers Extensive Italy Overseas Sales UK Sales Branch GBP Exp= Sales = GBP 450K Customers in 50,000/Month Spain per month•Net Long EUR 1.875 million/month GBP Exp•Also Net “Long” GBP 400K/Month JPY Exp= Japan Branch Customers in•But Net short JPY 45 million/month even 125MM/Month Sales= JPY 80MM Swedenwith JPY Revenue per Month JPY•Long CAD 100K/Month Exp•Latin America Sales in USD Sales to Customers in Customers in Latin Eastern America Europe 12
  13. 13. Hedging StrategiesJoe O’LearySenior Foreign Exchange Trader,Silicon Valley Bank 13
  14. 14. Definition of Foreign Exchange Hedging• “We use financial instruments to mitigate exposure”• “Entails giving up some opportunity / gains to reduce risk”• “Protects my revenue”• “Foreign exchange hedging is a financial strategy used to protect my business against volatility in world currency markets”• Important to have “cash flow predictability” 14
  15. 15. Market Forecasts vs. Reality ■ Predicted ■ Actual Source: Reuters 15
  16. 16. Risk Curve Analysis – Standard Deviation EUR/USD 1.55 EUR/USD 1.55 1.5 1.5 1.45 1.45 1.4 1.4 Probability 1.35 1.35 1.3 1.3 1.25 1.25 1.2 1.2 Source: Bloomberg 16
  17. 17. Common Misconceptions 17
  18. 18. Misconception: Hedging is a Form of SpeculationReality• Not hedging is actually a form of speculation• Hedging is another risk management strategy• Look at competition• Over-hedging could be speculating 18
  19. 19. Misconception: Foreign Exchange MovementsEven Out Over TimeReality• What is your time horizon? Source: Bloomberg 19
  20. 20. Misconception: A Company is Immune toForeign Currency DynamicsReality• Pricing and reporting in USD does not mitigate currency risk• Company size does not matter• Both private and public companies can benefit from FX hedging 20
  21. 21. Misconception: Too Time Consuming • Average time spent on the programs was 3 hours a month • 4 hours at quarter end • Most time consuming process was gathering cash forecasts 21
  22. 22. Getting Started 22
  23. 23. When to Consider FX Hedging• Selling overseas• Buying from overseas suppliers• Setting up manufacturing facilities overseas• Outsourcing R&D or customer support• Overseas acquisitions• Balance sheet revaluations• Competing with overseas competitors 23
  24. 24. Getting StartedANALYSIS DEVELOP FX POLICY CHOOSE STRATEGY MONITOR EVENTS AND EXECUTE AND RESULTS 24
  25. 25. AnalysisData collection to identify global exposure• Forecasted sales, purchases, profits, dividends• Firm commitments – sales or purchases not yet booked• Transactions booked – A/R, A/P• Inter-company transactions / transfers• Short and long term investmentsExposure Analysis• Quantify exposure to determine financial impact• Compare quantified risk with cost of hedging 25
  26. 26. Strategic Approach to RiskHIGH Fully Hedged PROBABILITY Partially Hedged No Hedge: Actively Tracked No Hedge: Reviewed Regularly LOW $ IMPACT HIGH 26
  27. 27. Develop a Foreign Exchange PolicyFX Policy• A framework approved by the board that incorporates all aspects of FX risk management o Reflect corporate goals and objectives o Buy-in from management o Ensure commitment of resources o Consistency in FX activities o Accounting issues 27
  28. 28. Develop a Foreign Exchange Policy – cont.Policy Components• Objectives• Risk tolerance-Passive? Active?• Hedging strategies• Accountability/oversight• 100% of corporations that hedge have an FX policy 28
  29. 29. Choosing the Right Strategy and ExecutingCommon Hedging Instruments• Natural offset- Currency accounts• Forward contracts• Over-the-counter options• Structured option strategiesWork with your accounting and senior management to ensure yourselected instruments are appropriate for your company. Are they inyour FX policy? 29
  30. 30. Monitor Events and Results• Ensure exposures are being hedged as planned• Develop regular reports to evaluate success of hedges in meeting goals o Mark-to-market report o Exposure report• Be alert to events or FX rate changes that may affect your business• Identify/learn new hedging tools 30
  31. 31. Common Hedging PracticesAssociation of Corporate Treasurers• 90% centralized hedge management• 80% hedge cash forecasts (AP, payroll, AR, cash balances)• 80% Net FX assets and liabilities• 80% hedge to minimize risk (transactions and earnings)
  32. 32. Common Hedging Strategies 32
  33. 33. Natural Offset• Easier and less time consuming• Utilizing non- USD accounts to collect and pay in same currency• Allows for cross currency trades to help mitigate risk. Higher correlation (AUD,GBP, EUR, CAD) 33
  34. 34. “No Free Lunch” Flexibility/Upfront costs Least Most Forwards Options 34
  35. 35. Forwards/Window Forward• Contractual agreement that your foreign currency payment or collection, scheduled to take place on a particular date in the future, will be converted at a fixed date and fixed exchange rate regardless of market fluctuations.• No upfront costs• Protect against currency depreciation/appreciation• However, NO benefit, should the currency move in your favor• Window forward - adds more flexibility only the timing. The value date is not a fixed date but a window of time. Great for A/R. 35
  36. 36. Forward Contract- Example EUR 1,500,000 Sold on 60 day terms. PO received 30 days before shipment Medical Device One Time Large Systems Company Order from Selling to USA Regional Hospital customer base Group in Europe EUR 1,500,000 Sales ProceedsUpon receipt of firm Purchase Order the Med Device due 60 days afterCompany is “long” EUR for 90 days and is “exposed” to the invoicerisk of fluctuations reducing USD proceeds on the day thebuyer pays the EUR 1.5 million • SVB buys your 1.5 Mio. EUR at 1.4255(1.4285-.0030), Value 8/31/11 • Window: SVB buys 1.5M EUR at 1.4250(1.4285-.0035), Value 8/15/11 to 9/15/11 36
  37. 37. Plain Option• An Option gives the buyer the right, but not the obligation to fulfill the option at maturity• The premium is the cost paid by the buyer of the option• The strike price is the rate at which the option is valued• An “insurance policy”• Regulatory concerns 37
  38. 38. Option Example EUR 1,500,000 Sold on 60 day terms. PO received 30 days before shipment Medical Device One Time Large Systems Company Order from Selling to USA Regional Hospital customer base Group in Europe EUR 1,500,000 Sales ProceedsUpon receipt of firm Purchase Order the Med DeviceCompany is “long” EUR for 90 days and is “exposed” to the due 60 days afterrisk of fluctuations reducing USD proceeds on the day the invoicebuyer pays the EUR 1.5 million • Buy a EUR put, strike at 1.4255, maturity 8/31/11 • Premium is 2.5% •At maturity, if EUR >1.4255 = don’t execute option •At maturity, if EUR < 1.4255= execute and sell at 1.4255 38
  39. 39. Financial Reform Update – Issued May 2012• Treasury Notice of “Proposed Determination on Foreign Exchange Forwards and Swaps”• Background: Dodd Frank Act Financial Reform federal initiatives to further control use of financial derivatives• Widespread effort to exclude foreign exchange instruments• Treasury Notice exempted FX Forwards and Swaps from the new restrictions and limits on financial derivatives to be applied to interest rate and other derivative financial instruments• However FX options and hybrids and non-deliverable forward contracts were not protected from the new provisions which could include: o Cash margins o Move trading to an exchange o Increased financial reporting 39
  40. 40. Questions? 40
  41. 41. Contacts 41
  42. 42. Ed Sauve Ed Sauve is the senior advisor for the Global Financial Services Group of Silicon Valley Bank and he has 20 plus years of commercial banking experience including provision of credit and delivery of a wide variety of financial services to small business, middle market, institutional and multi-national companies. Sauves international banking experience includes assignments in London, Middle East and Hong Kong. He opened Middle East Area Representative office for First Interstate Bank in the United ArabEd Sauve Emirates and led a program to obtain license to open its bank office inSenior Foreign Exchange Advisor Beijing, China. Currently he supports the international activities of SVBsesauve@svb.com Southern California-based clients.949.754.0816 His domestic experience includes management of regional corporate centers in Los Angeles and the South Bay for Wells Fargo/First Interstate, as well as regional responsibility for marketing Silicon Valley Banks short-term money market capabilities in Southern California. He has transaction experience in commercial lending, cash management, corporate finance, short-term money market investments and international banking. 42
  43. 43. Joe O’Leary Joe OLeary has over 14 years of experience working in the financial services industry. As a seasoned foreign exchange professional his knowledge extends from consultative marketing in foreign exchange principals, extensive knowledge of currency risk management and experience in gathering, evaluating, and hedging foreign exchange exposures for multinational corporations. His duties have included offshore interest rate products, asset liability management, foreign exchange trading and corporate foreign exchange risk management. OLeary joined SVB in May of 2006 as a foreign exchange advisor. Currently in his capacity as senior foreign exchange trader, he prepares custom hedging strategies for clients with complex currency-related issues, advises clients in developing, implementing, and monitoring foreign exchange strategies and educates clients in Joe O’Leary understanding foreign exchange products. In addition, OLeary manages SVBs non- Senior Foreign Exchange Trader USD loan portfolio and mitigates the banks FX exposure. joleary@svb.com 408.654.1017 Prior to joining SVB, OLeary was a treasury manager at a large hard disk drive manufacturer based in, California, where he managed the corporations foreign exchange exposure. Additionally, OLeary worked with overseas offices on cash forecasting, standby letters of credit and general ledger accounts. OLeary began his career at the Bank of Hawaii (BOH) where he held various positions within the banks treasury department. OLeary holds a bachelors degree in International Business from the University of Hawaii, Honolulu. He also holds a certificate on foreign exchange principles from the World Trade Institute in New York, New York, and OLeary is a member of the Association for Financial Professionals. 43
  44. 44. AdvisorsWest West Central EastDave Bhagat Mary Jo Mack Matt Wysong Carla WinfieldSenior FX Advisor Senior FX Advisor Trade Finance Advisor Senior Trade Finance Advisor 415.806.5341 303.378.7024650.320.1158 617.630.4154 mjmack@svb.com mwysong@svb.comdbhagat@svb.com cwinfield@svb.com Todd Brothers Laurence HaywardDennis Brown Senior FX Advisor Senior FX Advisor Drew DevineSenior Trade Finance Advisor 415.764.3153 FX Advisor tbrothers@svb.com 972.455.0961949.754.0838 617.630.4145 lhayward@svb.comdbrown@svb.com ddevine@svb.comEd Sauve Paul Jennings Senior FX AdvisorSenior FX Advisor 617.796.6934949.754.0816 pjennings@svb.comesauve@svb.com Scott PetruskaJoe O’Leary Senior FX AdvisorSenior FX Trader 617.796.6930408.654.1017 spetruska@svb.comjoleary@svb.com 44
  45. 45. SVB’s Foreign Exchange DeskToll Free: 888.313.4029FXTraders@svb.com 45
  46. 46. DisclosuresForeign exchange transactions can be highly risky, and losses may occur in short periodsof time if there is an adverse movement of exchange rates. Exchange rates can be highlyvolatile and are impacted by numerous economic, political and social factors, as well assupply and demand and governmental intervention, control and adjustments. Investmentsin financial instruments carry significant risk, including the possible loss of the principalamount invested. Before entering any foreign exchange transaction, you should obtainadvice from your own tax, financial, legal and other advisors, and only make investmentdecisions on the basis of your own objectives, experience and resources. Opinionsexpressed are our opinions as of the date of this content only. The material is based uponinformation which we consider reliable, but we do not represent that it is accurate orcomplete, and it should not be relied upon as such. 46
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