FiREapps Currency 101

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  • 1. Foreign Exchange Hedging Tutorial: Currency Impacts 101 Foreign Exchange Impacts on Corporate Value Merrill Lynch Analyst & Investor Presentation Presented by FiREapps October 31, 2008
  • 2.
    • This presentation is copyright 2008 Rim Tec Inc., all rights reserved. Any unauthorized reproduction or distribution is prohibited. Any authorized reproduction or distribution of this presentation must include this copyright notice and shall not remove or alter any references to Rim Tec or the FiREapps Service or other Rim Tec products or services contained herein.
    Copyright 2008 Rim Tec Inc. Slide
  • 3. Speaker Introductions
    • Wolfgang Koester, CEO, FiREapps
    • Managed risk for a Fortune 500 companies & governments, including G-10s, since 1986
    • Monthly contributor to AFP Exchange magazine & member of AFP Risk editorial board
    • One of Treasury and Risk magazine’s 2008 “100 Most Influential People in Finance”
    • Member Global Exchange 2007 “Who’s Who in Foreign Exchange”
    • Contributor to Treasury and Risk, Corporate Board Member, Business Finance, eForex and GT News
    • CFO, Fortune, Wall Street Journal and the Economist
    Copyright 2008 Rim Tec Inc. Slide
  • 4. Index: Currency Impacts on Corporations Impact Exposure Net Risk Actions Risk Solution
    • Income Statement, Balance Sheet
    3.Operational & Financial (hedging) 4. What you should ask as an investor / analysts / board member
    • Introduction
    Copyright 2008 Rim Tec Inc. Slide
  • 5. Discussion Overview Copyright 2008 Rim Tec Inc. Slide
    • “ There is No Free Pass for Foreign Exchange ”
      • Treasurer, Microsoft
    • Pharmaceutical Company FX Impacts
    • 10Q – Johnson & Johnson – Released 8/4/2008
      • Located in ‘Item 2 – Management’s Discussion & Analysis
      • “ For the first fiscal six months of 2008, worldwide sales were $32.6 billion, a total increase of 8.2% including an operational increase of 2.8% over 2007 first fiscal six months sales of $30.2 billion. Currency had a positive impact of 5.4% for the per iod.”
      • 10K – Bristol Myers Squibb – Released 2/22/2008
      • Located in ‘Results of Operations’
      • Net sales from continuing operations for 2007 increased 12% to $19.3 billion, including a 3% favorable foreign exchange impact, compared to 2006. U.S. net sales in 2007 increased 18% to $10.8 billion compared to 2006. International net sales in 2007 increased 5% to $8.5 billion compared to 2006, including a 7% favorable foreign exchange impact.
    • Solution
      • FA Client Quote: “We have no FX Surprises”
  • 6. A Perfect Storm Copyright 2007 Rim Tec Inc. Slide
  • 7. The Beginning of the Problem Business Units Corporate Controllers Banks and Trading Platforms Complex Exposure Reporting Spreadsheets Controller Treasurer 1. Accounting 2. Actions Copyright 2008 Rim Tec Inc. Slide Several days
  • 8. Translate Your Financial Statements into Reporting Currency Copyright 2008 Rim Tec Inc. Slide
  • 9. Currency Definitions
    • Local
      • The currency of the country of domicile
    • Functional
      • The currency of the primary economic environment in which the entity operates; normally the currency in which an entity generates and expends cash
      • FAS 52 introduced the concept of functional currency
    • Transaction
      • The currency in a business transaction has been executed
    • Reporting
      • The currency in which an enterprise prepares its financial statements
    Copyright 2008 Rim Tec Inc. Slide
  • 10. FASB Statement No.52
    • Foreign Currency Translation
    • Affects the financial reporting of companies operating in foreign countries
    • Provided information that is compatible with the expected economic effects of a rate change on an enterprise’s cash flows and equity
      • Adjustments for impacts that do not effect cash flow are excluded from net income
    Copyright 2008 Rim Tec Inc. Slide
  • 11. FASB Statement No.133
    • Accounting for Derivative Instruments & Hedging Activities
    • A hedge of a forecasted event is a ‘cash flow hedge’
    • The results from cash flow hedges must be evaluated
      • The ineffective part goes to the Income Statement
      • The effective part is posted to Other Comprehensive Income (OCI) in the Balance Sheet
    • Amounts in OCI are reclassified to the Income Statement when the forecasted cash flow affects earnings
    Copyright 2008 Rim Tec Inc. Slide
  • 12. R= E x v
    • Exposure
    x Volatility Risk = $100,000 = $1,000,000 x 10% Copyright 2008 Rim Tec Inc. Slide
  • 13.
    • Exposure
    R= E x v x Volatility Risk = $100,000 = $,1000,000 x 10% Complete Understanding Copyright 2008 Rim Tec Inc. Slide September 2008 Exposure  Volatility  Risk (One Week) G10 Currencies $70MM 10% = $7M Non-G10 Currencies $30MM 25% = $7.5M
  • 14.
    • Exposure
    R= E x v x Volatility Risk = $100,000 = $1,000,000 x 10% Complete Understanding Time Copyright 2008 Rim Tec Inc. Slide September 2008 Exposure  Volatility  Risk (One Week) G10 Currencies $70MM 10% = $7M Non-G10 Currencies $30MM 25% = $7.5M September 2008 Exposure  Volatility  Risk (One Day) G10 Currencies $70MM 1% = $0.7M Non-G10 Currencies $30MM 3.2% = $0.96M
  • 15. Index: Exposure Income Statement & Balance Sheet Impact Exposure Risk 2.Income Statement, Balance Sheet 1. Introduction Copyright 2008 Rim Tec Inc. Slide
  • 16. FX Impacts to the Income Statement Income Statement
    • Foreign currency-denominated revenues & costs are translated to USD each reporting period
      • Fluctuating exchange rates affects reported revenues and costs
    • FX gain/loss results from Balance Sheet transactions
      • Realized from clearing foreign currency denominated monetary assets & liabilities
      • Unrealized from FAS 52 remeasurement of monetary assets & liabilities at month end
    Copyright 2008 Rim Tec Inc. Slide Companies doing business in foreign currencies risk NOI , Net Income & EPS impact Revenue Costs (COGS + Opex) Net Operating Income Other Income/expenses FX Gain/Loss Net Income Shares Outstanding EPS
  • 17. FX Impacts to the Balance Sheet Domestic Balance Sheet
    • FX can significantly affect asset-liability balances when translated
    • Some of translation does not flow through the income statement (i.e. equipment)
      • Recorded as cumulative translation adjustment (CTA) in Other Comprehensive Income (OCI)
      • CTA taken into account when a disposition occurs
    Copyright 2008 Rim Tec Inc. Slide International Balance Sheet Assets Liabilities Stockholder’s Equity Assets Liabilities Stockholder’s Equity OCI (CTA) “The Plug”
  • 18. Accounting Impacts & FAS 52 translation Copyright 2008 Rim Tec Inc. Slide translation No fx gain/loss from remeasurement Translation gain/loss (CTA) fx gain/loss from remeasurement No translation gain/loss (CTA) Transaction Currency Functional Currency Reporting Currency Result Example 1 Revenue EUR EUR USD USD value of EUR revenue at risk Example 2 Revenue EUR USD USD USD Value of EUR revenue at risk Example 3 A/R EUR EUR USD No income statement effect; only CTA adjustment in Balance Sheet Example 4 A/R EUR USD USD Income statement effect from FAS 52 remeasurement; no CTA adjustment
  • 19. Impacts of a Rising Dollar Example: EUR Revenue Financial Statement Risk Notes Copyright 2008 Rim Tec Inc. Slide Result: $.27 (17%) difference between projected revenue & cash collection Q3 Guidance EUR USD Rate=1.55 August Sale 120 day payment terms Aug EUR Rate=1.50 Revenue EUR Revenue translated at August average rate August Month-end Balance Sheet Rate=1.45 FX gain/loss Account Receivable Remeasurement September Month-end Balance Sheet Rate=1.40 FX gain/loss Account Receivable Remeasurement December 27 Month-end Balance Sheet rate=1.28 FX gain/loss A/R Collected, Converted to USD
  • 20. Index: Actions Operational & Financial Impact Exposure Actions Risk 2.Income Statement, Balance Sheet 3. Operational & Financial (hedging) Copyright 2008 Rim Tec Inc. Slide
  • 21. How Do You Get Your House in Order?
    • Understand your exposure
    • Take action - operational
    Copyright 2008 Rim Tec Inc. Slide
  • 22. How Do You Get Your House in Order?
    • Take Action - Hedge
  • 23. How Do You Get Your House in Order?
    • Income Statement Hedging
    • Protecting the USD value of non-USD revenue & costs–Cash flow hedging; focused on top-line & NOI
    • Typical time horizon: 6 months to 3 years
    • FASS 133 for hedge accounting treatment–want to match hedge results to when the forecasted transactions occur
    • Effective hedges are recorded & held in OCI (Balance Sheet) until the forecasted transactions occur; ineffectiveness flows immediately to the income statement
    Copyright 2008 Rim Tec Inc. Slide
  • 24. Transaction Currency/Functional Currency and Impact on Cash Flow Hedging Copyright 2008 Rim Tec Inc. Slide Hedging Relationship Risk Transaction Currency Functional Currency Reporting Currency Cash Flow Hedge? Example 1 Revenue EUR USD USD Can hedge EUR-USD risk Example 2 Revenue EUR EUR USD Cannot hedge EUR-USD risk Example 3 Revenue EUR GBP USD Cannot hedge EUR-USD risk
  • 25. How Do You Get Your House in Order?
    • Balance Sheet Hedging
    • Reducing the volatility of the FX gain/loss line in the income statement – part of managing Net Income/EPS risk
    • FX gain/loss results from:
      • Clearing recorded monetary assets/liabilities on the balance sheet (realized)
      • Remeasurement of monetary assets/liabilities at period end (unrealized)
    • Hedge results are recognized currently in the income statement
    • Overhedging typically occurs due to a lack of complete & timely understanding of exposures
    Copyright 2008 Rim Tec Inc. Slide Assets Liabilities OE OCI (CTA)
  • 26. Impacts of a Rising Dollar Example: EUR Revenue Financial Statement Risk Hedge Actions Copyright 2008 Rim Tec Inc. Slide Result: Reduced currency impacts on your corporation Q3 Guidance EUR USD Rate=1.55 Cash Flow Hedge – FAS133 Hedge accounting August Sale 120 day payment terms Aug EUR Rate=1.50 Revenue Cash Flow Hedge Expires Balance sheet hedge of A/R – 120+ days August Month-end Balance Sheet Rate=1.45 FX gain/loss Balance sheet hedge Continues September Month-end Balance Sheet Rate=1.40 FX gain/loss Balance Sheet Hedge Continues December 27 Collection Balance Sheet rate=1.28 FX gain/loss Close Balance Sheet Hedge when Cash is Converted
  • 27. Index: Currency Impacts on Corporations Copyright 2008 Rim Tec Inc. Slide Impact Exposure Net Risk Actions Risk Solution 2.Income Statement, Balance Sheet 3. Operational & Financial (hedging) 4. What you should ask as an investor / analysts / board member 1. Introduction
  • 28. Recommendations
    • What Should You an Analyst / Investor / Constituent Do With All This?
    Copyright 2008 Rim Tec Inc. Slide
  • 29. Recommendations
    • Understand that FX exposure management is complex & difficult
    • Drive for succinct answers to four questions
        • What are your exposures-past, present & forecasted?
          • Income statement [impact on NOI, NI & EPS)
          • Balance sheet [impact on OCI (CTA)]
        • What actions are you taking to protect corporate value?
        • What net risk are you managing towards (exposure x volatility)?
        • What was your actual risk?
    • For historic purposes, examine earnings releases, 10K (incl. Item 7a) & 10Q (incl. Item 3)
    Copyright 2008 Rim Tec Inc. Slide
  • 30. Example Exposure Net Risk Actions Risk Balance Sheet Exposure = $1.2B Actions: <$800M> $400M x 10% (Vol) = $40M Net Risk Copyright 2008 Rim Tec Inc. Slide
  • 31. FiREapps Solution Copyright 2008 Rim Tec Inc. Slide
    • Aggregate FX data for Balance Sheets & Cash Flows at the Push of a Button
      • Creates transparency & understanding (completeness)
      • Can act within hours (not weeks, or months)
    • Result
      • No Surprises
      • Volatility ↓
      • Cost ↓
      • Less hedges
      • Improve Communications
      • Enable Compliance
      • Improve Operational Efficiency
      • Less time on aggregation
      • More value add
  • 32. Thank You
    • For More Information
    • View this presentation online at www.fireapps.com/news/presentation.html
    • Contact FiREapps
      • Email: [email_address]
      • Phone: 480-443-7333 x157
    • Visit our Web site at www.fireapps.com
      • Attend live and recorded Webinars
      • Download whitepapers
      • Read related trade and business articles
    Copyright 2008 Rim Tec Inc. Slide