This paper discusses the Nodal Logistics case study and which option would carry the least risk. Then compares their strategy with Google's and discusses whether they are both reducing risk or increasing it.
This was for the subject Building Financial Relationships in my Masters program at Northeastern University, MA.
I hope it gives you a broad understanding of how to manage currency exchange risk.
Matt
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Hedging Strategies & Risk
1. Individual Case β Hedging Strategies
Hedging can be quite a profitable business strategy, even if you are only trying to mitigate
market risk. Nodal Logistics and Google are two companies that have chosen to pursue
hedging for different reasons. What are the options available to them? Why strategies
have they chosen or should choose? And, are they reducing risk or just creating more?
Nodal Logisticsβ Hedging Options
Nodal Logistics - a US based commercial real estate company - have never had to deal
with foreign currency risk, yet in the purchase of property in Brazil they are faced with
the volatility of the real against the US dollar, which could have a significant impact on
their earnings from rent. The reason for this is, has always, βwrote its leases (from which
the company generated its cash flows) in U.S. dollar terms and, as such, financial hedging
instruments [had never been] necessary.β
Listed below are the options Nodal have:
1. Take the, βcurrency risk,β and buy real, hoping it will appreciate in future. This
seemed to be a favourable option because the real had, βconsistently appreciated
against the dollar over the past three yearsβ
2. Lock in an exchange rate with the bank until a certain future date, with currency
projections against the spot rate though; this is not a favourable option.
3. Use Currency Put Options to lock in an, βassured minimum rate of exchange,β if the
real plummets in value against the US dollar. This creates problems though if the real
rises in value against the US dollar and John already picked a floor that was too low;
this would mean missing out on potential earnings.
4. Sharing the currency risk with tenants in the form of CACβs or Currency Adjustment
Clauses. This would allow tenants and Nodal to agree on the exchange rate for a
certain period or percentage fluctuation in the strike price. Problems arise with this
model though, as many tenants may not want to sign currency agreements and this
would leave a higher percentage of the factories vacant.
5. Financing a portion of Nodalβs debt in the construction of the property with real, in an
attempt to reduce the, βtotal equity risk and exposure.β This does not seem to be a
good idea, as the Brazilian exchange rate quoted was a five year fixed rate, at 15%.
6. Last, swapping a portion of US dollars for real consistently over time, trying to, βde-
sensitizeβ Nodal in movements of the real. This however just seems like buying real
Nodal Logisticsβ Future Strategy
Similar to Google, Nodalβs hedging strategy should be about protecting earnings. The real
can fluctuate wildly but it only affects Nodal once converted back into US dollars, βeach
and every period to meet REIT requirements for profit distributions.β Purchasing currency
options β especially with the realβs chaotic history β seem the smartest option. However,
to mitigate some of the risk involved with the US dollar to real exchange, a shorter
maturity date should be negotiated with the Nodal Logisticsβ bank. This means that Nodal
would purchase currency options in each quarter β just like Google β that would reach
maturity at the end of the five year period, therefore reducing the outlay of capital the
inherent risk.
2. Googleβs Hedging Strategy
Google strategy is fairly simple; protect profit from fluctuations in foreign currency
exchange by purchasing currency options. Since Google trades in multiple countries, this
requires many different options to reduce risk. Reducing exposure to the strike price of a
foreign currency, Google purchases a portion of its options with an 18 month maturity,
the remaining purchased every 4 months within the 18 month period. This reduces the
overall capital needed up-front and the risk related to movement in the exchange rate.
This is a constant process, in each 4 month period there are options expiring, open
options and bought options; each reducing future risk .
While Googleβs hedging strategy is not designed to generate profits, it does. Betting the
US dollar would drop in value has been quite successful in the last few years, netting over
$200m dollars since the programβs beginning. While put options are designed to protect
profit from foreign currency fluctuations, Google has shown they do not create future risk
if used correctly.
Reference List
Google Investor Relations 2013, Google Hedging 101 Video, viewed 15 July 2014,
<https://www.youtube.com/watch?v=-3rvoAkgB5Y>.
Moffett, M 2008, Nodal Logistics and Custo Brasil, Harvard Business Review, viewed 15
July 2014, <http://hbr.org/product/nodal-logistics-and-custo-brasil/an/TB0049-PDF-
ENG>.
Schoenberger, C 2011, Google's Currency Hedges the Right Bet, viewed 15 July 2014,
<http://online.wsj.com/news/articles/SB100014240527487039566045761103042433572
50>.