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Mitigating FX Risk in Corporate Portfolio

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Mitigating FX Risk in Corporate Portfolio
BY :- RAHUL MAGAN
CHIEF EXECUTIVE OFFICER - TREASURY CONSULTING LLP
COUNTRY DIRECTOR – INTERNATIONAL INSTITUTE OF CERTIFIED FORENSICS INVESTIGATION PROFESSIONALS, INC.
COUNTRY DIRECTOR – ASSOCIATION OF CERTIFIED FORENSICS INVESTIGATION PROFESSIONALS (ACFAP)
7/2/20161
 Managing FX Risk in Corporate Portfolio:- Foreign Exchange Risk is turning out to be a
biggest risk for all Corporates across the world as majority of the Corporates are getting
Globalized in nature. As more and more Corporates are getting Globalized in nature hence
forth more the exposure towards Foreign Exchange Risk…
 Foreign Exchange Risk Exposures :- Foreign Exchange Exposure is the sensitivity of the
real domestic currency value of assets, liabilities, or operating incomes to unanticipated
changes in exchange rates
Mitigating FX Risk in Corporate Portfolio
Foreign Exchange Exposure
Balance Sheet Impact P&L Impact
Goes in OCI & impacts Equity Goes in P&L and impacts EPS
7/2/20162
UNDERSTANDING THE EXCHANGE
RISK MANAGEMENT PROBLEM
 Value of hedging
 Goals
 Nature of the business
MEASUREMENT OF EXPOSURE
ACCOUNTING TRANSACTION ECONOMIC
NATURE OF THE CASH FLOW EXPOSURE:
 One-shot?
 Linear?
 Contingent on exchange rates?
 Contingent on other events?
HEDGING METHODS
OPERATIONAL FINANCIAL
Linear
 Forwards
 Futures
 Debt
 Currency swaps
Exchange-rate
contingent
 Options
 Debt with option
features
Contingent on
other events
 Event options
 Probability-based
hedging
Examples:
 Sourcing flexibility
 Pricing strategy
 Market
diversification
A Corporate Foreign Exchange Roadmap
7/2/20163
The Exposure Triangle – Corporates Balance Sheet
Transactions
Exposure
Translation
Exposure
Economic
Exposure
7/2/20164
• Three types of Exposure:
- Translation or Accounting Exposure
- Transaction or Contractual Exposure
- Operating or Economic Exposure
FOREIGN EXCHANGE RISKS EXPOSURE – TYPES - I
Foreign Exchange Exposure
Translation Exposures Transaction Exposure Economic Exposure
Goes in B/S in OCI Goes in P&L Goes in P&L 7/2/20165
• Translation or Accounting Exposure:
Is the sensitivity of the real domestic currency value of Assets and Liabilities,
appearing in the financial statements to unanticipated changes in exchange rates.
The impact of Translation Gains/(Losses) goes in Balance Sheet in Other
Comprehensive Income (OCI)
FOREIGN EXCHANGE RISKS EXPOSURE - Types - II
• Transaction or Contractual Exposure:
Is the sensitivity of the real domestic currency value of Assets and Liabilities, when
assets and liabilities are liquidated with respect to unanticipated changes in
exchange rates for exporting, importing, or import-substituting firms. The impact or
Transaction exposure goes in P&L at revaluation rate.
• Economic or Operating Exposure:
Is the sensitivity of the real domestic currency value of Assets and Liabilities, or future
operating incomes to unanticipated changes in exchange rates. The impact of
Economic exposure goes in P&L at revaluation rate.
7/2/20166

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Mitigating FX Risk in Corporate Portfolio

  • 1. Mitigating FX Risk in Corporate Portfolio BY :- RAHUL MAGAN CHIEF EXECUTIVE OFFICER - TREASURY CONSULTING LLP COUNTRY DIRECTOR – INTERNATIONAL INSTITUTE OF CERTIFIED FORENSICS INVESTIGATION PROFESSIONALS, INC. COUNTRY DIRECTOR – ASSOCIATION OF CERTIFIED FORENSICS INVESTIGATION PROFESSIONALS (ACFAP) 7/2/20161
  • 2.  Managing FX Risk in Corporate Portfolio:- Foreign Exchange Risk is turning out to be a biggest risk for all Corporates across the world as majority of the Corporates are getting Globalized in nature. As more and more Corporates are getting Globalized in nature hence forth more the exposure towards Foreign Exchange Risk…  Foreign Exchange Risk Exposures :- Foreign Exchange Exposure is the sensitivity of the real domestic currency value of assets, liabilities, or operating incomes to unanticipated changes in exchange rates Mitigating FX Risk in Corporate Portfolio Foreign Exchange Exposure Balance Sheet Impact P&L Impact Goes in OCI & impacts Equity Goes in P&L and impacts EPS 7/2/20162
  • 3. UNDERSTANDING THE EXCHANGE RISK MANAGEMENT PROBLEM  Value of hedging  Goals  Nature of the business MEASUREMENT OF EXPOSURE ACCOUNTING TRANSACTION ECONOMIC NATURE OF THE CASH FLOW EXPOSURE:  One-shot?  Linear?  Contingent on exchange rates?  Contingent on other events? HEDGING METHODS OPERATIONAL FINANCIAL Linear  Forwards  Futures  Debt  Currency swaps Exchange-rate contingent  Options  Debt with option features Contingent on other events  Event options  Probability-based hedging Examples:  Sourcing flexibility  Pricing strategy  Market diversification A Corporate Foreign Exchange Roadmap 7/2/20163
  • 4. The Exposure Triangle – Corporates Balance Sheet Transactions Exposure Translation Exposure Economic Exposure 7/2/20164
  • 5. • Three types of Exposure: - Translation or Accounting Exposure - Transaction or Contractual Exposure - Operating or Economic Exposure FOREIGN EXCHANGE RISKS EXPOSURE – TYPES - I Foreign Exchange Exposure Translation Exposures Transaction Exposure Economic Exposure Goes in B/S in OCI Goes in P&L Goes in P&L 7/2/20165
  • 6. • Translation or Accounting Exposure: Is the sensitivity of the real domestic currency value of Assets and Liabilities, appearing in the financial statements to unanticipated changes in exchange rates. The impact of Translation Gains/(Losses) goes in Balance Sheet in Other Comprehensive Income (OCI) FOREIGN EXCHANGE RISKS EXPOSURE - Types - II • Transaction or Contractual Exposure: Is the sensitivity of the real domestic currency value of Assets and Liabilities, when assets and liabilities are liquidated with respect to unanticipated changes in exchange rates for exporting, importing, or import-substituting firms. The impact or Transaction exposure goes in P&L at revaluation rate. • Economic or Operating Exposure: Is the sensitivity of the real domestic currency value of Assets and Liabilities, or future operating incomes to unanticipated changes in exchange rates. The impact of Economic exposure goes in P&L at revaluation rate. 7/2/20166
  • 7. 1. Current/Non-Current Method: All current assets and current liabilities are translated at current exchange rate 2. Monetary/ Non-Monetary Method: All monetary assets and liabilities are translated at current exchange rate 3. Temporal Method: Same as Monetary/Non-Monetary method BUT inventory may be translated at current exchange rate IF it is shown at market value 4. Current Rate Method: All balance sheet and income statement items are translated at current exchange rate FOREIGN EXCHANGE EXPOSURES – ACCOUNTING TREATMENT Monetary / Non Monetary Temporal Accounting Exposures Current/Non Current Current Rate 7/2/20167
  • 8. Foreign Exchange Transaction Exposure  Transactions exposure results from particular transactions such as an export where a known cash flow in a given currency will take place at a certain date  Example: If Intel invoices a German company in Deutsche marks for a semiconductor shipment then the firm has German mark exposure and can hedge this by borrowing marks.  This kind of exposure is readily hedgable using forwards, futures or debt  Transactions exposure arises when a company must pay or receive a foreign currency at an unknown future exchange rate  It is contractual  It affects the income statement  It can often be hedged directly using forwards, futures or currency options Cash Flow Hedging 7/2/20168
  • 9. Recognition of Exchange Gains & Losses Exchange Gain/Loss Transaction Gain/Loss Translation Gain/Loss Trans- action Date Financial Statement Date Settle ment date Financial Statement Date Financial Satement date Translation Transaction 7/2/20169
  • 10. Foreign Exchange Fair Value Exposure  Fair value exposure (accounting exposure) results from the way accounting conventions dictate that a company’s foreign assets and liabilities should be booked.  Example: If Intel’s assets in Ireland are regarded as denominated in Irish punts, then the subsidiary’s accounting value is exposed to the punt and the firm may wish to hedge this exposure by financing in punts. Hedging of Fair Value Exposures Onshore Markets Offshore Markets Onshore & Offshore Markets Singapore, NY, HK, Australia Markets Domestic Markets Fair Value Hedging 7/2/201610
  • 11. Currency Risks: Economic Exposure Change in the economic value of the firm resulting from unanticipated exchange rate changes.  Booked vs. anticipated transactions  Expected vs. unexpected changes; the "cost of hedging"  Exposure and the parity assumptions: "We are not exposed in the long run"  Currency of denomination vs currency of determination; competition, elasticity's, etc. Economic Exposure – Hedging & Impact 7/2/201611
  • 12. Economic Exposure  Economic exposure is how the firm’s revenues and costs will respond to exchange rate changes.  Example: Even though Intel invoices German customers in marks, its future revenues may be unaffected by fluctuations in the mark if the currency of determination of prices in the semiconductor business is the dollar or even the yen.  The currency of determination is the currency in which most of the competition prices similar products.  Example: General Electric’s Yen Payables 7/2/201612
  • 13. Translation vs Economic Exposure Accounting exposure  Exposure = "Exposed" assets - "exposed" liabilities Economic exposure  Exposure = How will an unanticipated exchange rate change affect the cash flows of the firm?  Domestic sales  Exports  Domestic costs  Import costs 7/2/201613
  • 14. A Realistic Approach  Banks versus corporations: To the extent that the firm is like a bank, do bank-style hedging. Match financial assets with liabilities of the same kind.  Seek to identify economic exposure using product cost-and- market analysis, industry competitive analysis, or statistical analysis on the sensitivity of the company’s value to exchange rate changes.  Hedge economic exposure using debt/swaps for long term exposure, short term instruments for uncertain exposure, and options for disaster insurance 7/2/201614
  • 15. 7/2/2016 Developing a Hedging Program  Hedging Program:- With the rising Globalization almost all organizations are having Foreign Exchange exposures lying in their books which in turn impacts their Balance Sheet as well as Profit & Loss A/c. There are three types of exposures lying in Corporate Balance sheets. Types of Hedging Program Cash Flow Hedging Fair Value Hedging Net Investment Hedges Protecting Cash Flow exposures via approved derivatives instruments in Onshore & Offshore markets Protecting Fair value exposures via approved derivatives instruments in Onshore & Offshore markets Protecting Net Investments done by one Group company in other Group company in Foreign Currency. To protect Exports / fair value & Net Investments 15
  • 16. 7/2/2016 Developing a Hedging Program – Cash Flow Hedges  Cash Flow Hedging Program:- Cash Flow Hedges are taken to protect either near term or long term cash flows from the volatility in exchange rates. The same can be done via taking FX hedges not only in Onshore Treasury markets & Offshore Treasury markets using Derivatives contracts like Plain vanilla forwards contracts, Options , Swaps , Interest Rate Hedging , FRA and respective others. Cash Flow Hedging Onshore Derivatives Offshore Derivatives Local Treasury markets Plain Vanilla Derivatives, Options Contracts Swaps Interest rate Hedging FRA Respective others.. Offshore Treasury Markets – Australia , London, Singapore, NY, Dubai To protect Exports , Imports or VCF 16
  • 17. 7/2/2016 Developing a Hedging Program – Fair Value Hedges  Fair Value Hedging Program:- Fair value hedging program is devised to protect the fair value of the foreign currency assets & liabilities in books. All MNC having various subsidiaries across the world hence forth all subsidiaries are having various foreign currency assets & liabilities which needs to be revalue at the end of the month hence forth concept of fair value hedging is required. Fair Value Hedging Onshore Derivatives Offshore Derivatives Local Treasury markets Plain Vanilla Derivatives, Options Contracts Swaps Interest rate Hedging FRA Respective others.. Offshore Treasury Markets – Australia , London, Singapore, NY, Dubai 17
  • 18. 7/2/2016 Developing a Hedging Program – Net Investment Hedges  Net Investment Hedging Program:- Net Investment hedges are taken when a Group company has given a loan in the form of net investments in other Group company. The same would happen when parent company invested in Group company which is not the functional currency of the subsidiary hence forth hedging is required. Net Investment Hedging Onshore Derivatives Offshore Derivatives Local Treasury markets Plain Vanilla Derivatives, Options Contracts Swaps Interest rate Hedging FRA Respective others.. Offshore Treasury Markets – Australia , London, Singapore, NY, Dubai To protect Net Investments in Group Companies 18
  • 19. 7/2/2016 Hedging Instruments  Hedging Instruments:- Well with the rising complexities of derivatives instruments & exporting models there is a dire need for Corporate Treasurers to not only hedge their receivables but also payables having correct derivatives in place. Types of Derivatives Contracts Onshore Derivatives Offshore Derivatives Plain Vanilla Derivatives, Options Contracts, Swaps, Interest rate Hedging FRA, Respective others.. Types of Hedging Instruments Offshore markets offers another biggest derivatives instruments known as NDF ( Non Deliverable Forwards Contracts ) , NDO ( Non Deliverable Options) & NDS ( Non Deliverable Swaps ) where in there is nothing to deliver however settlement of net Gain/(loss) would happen. 19
  • 20. Biggest Risks covered via Derivatives 7/2/2016 Liquidity Risk Funding Risk Interest Rate Risk Foreign Exchange Risk Commodity Price Risk Credit Risk Business & Operating Risk Low Severity Treasury Risks High Severity Treasury Risks 20
  • 21. Derivatives - Robust Risk Management Framework 7/2/201621
  • 22. Derivatives - Risk Management Process 7/2/201622
  • 23. Interest Rate Risks – Types of Interest Rate Swaps (IRS)  Interest Rate Risks :- Treasury Interest rate risks are divided into various parts like Principal Only Swaps (POS), Coupon Only Swaps (COS), Interest Rate Swaps (IRS) , Overnight Index Swaps (OIS) and MIFOR Swaps 7/2/2016 Interest Rate Risks Coupon Only Swaps(COS) Principal Only Swaps (POS) Interest Rate Swaps (IRS) Overnight Index Swaps(OIS) Principal Only Swaps are those swaps where in company hedges only principal part and keep coupon open while Coupon Only Swaps are those swaps where in coupons are getting hedged while principal remains open. Interest Rate Swaps are those swaps where in there is only exchange of interest where as OIS are those which are subject to daily Interest rate movements in MIBOR or OIS however they are settled at an periodic dates. 23
  • 24. Offshore Treasury Markets 7/2/201624 FX Interest Rates hedging Commoditi es Credit Risk Equities Structured Debt Asian (including NDF) and G7 Currencies Vanilla / Exotic Options Cross Asset / Dual Factor Options Asian and G7 rates Vanilla and Exotics Interest Rate Derivatives Asian fixed income (USD, SGD, HKD, CNH, IDR, AUD)Total Return Swaps / Repo Vanilla / Exotic Equity Options( US, Europe & Asia)Equity Monetization Secured Financing / Receivables Securitization Total Return / Loan participation Notes Debt restructuring Metals, Energy, Agriculture & Freight Hedging & Investments
  • 25. Offshore Treasury Markets – Coverage 7/2/201625
  • 26. Offshore Treasury Markets – Treasury & Markets 7/2/201626
  • 27. Offshore Treasury Markets – Treasury & Markets 7/2/201627
  • 28. Currency & Interest Rate Curve Volatility 7/2/201628 USD/INR Currency Volatility USD/INR OIS Curve USD/PHP Currency Volatility USD/AUD Currency Volatility USD/CNY Currency Volatility USD/CAD Currency Volatility USD/JPY Currency Volatility GBP/EUR Currency Volatility Volatility in Asian & Commodities Currencies Volatility in Asian Interest Rate Indexes
  • 29. USD/INR Currency Volatility – Year 2010 – YTD 2014 7/2/201629
  • 30. USD/PHP Currency Volatility – Year 2010 – YTD 2014 7/2/201630
  • 31. USD/INR OIS Curve –YTD 2014 7/2/201631
  • 32. USD/AUD Currency Volatility –Year 2010 - YTD 2014 7/2/201632
  • 33. USD/CNY Currency Volatility –Year 2013 -YTD 2014 7/2/201633
  • 34. USD/CAD Currency Volatility –Year 2013 -YTD 2014 7/2/201634
  • 35. USD/JPY Currency Volatility –Year 2013 -YTD 2014 7/2/201635
  • 36. GBP/EUR Currency Volatility –Year 2013 -YTD 2014 7/2/201636