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7.international finance exposures

This document provides an overview of managing foreign exchange exposures and exchange rate fluctuations. It discusses the different types of currency exposures that companies face, including transaction, economic, and translation exposures. Transaction exposures arise from outstanding foreign currency obligations before exchange rates change. The document outlines how changing exchange rates can affect companies and provides examples of currency risk from imports, exports, and foreign borrowing. It also discusses factors that influence exchange rate movements and the objectives of foreign exchange risk management.

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Managing Exposures And Exchange Rate Fluctuations
Our Road Map Introduction & Overview Managing currency risks Raising Funds Abroad or in Fx Opportunities & Risks BOP Understanding Currency Exposures & Risk Managing the risks Fx Markets Exchange Rate Determination & Forecasting Capital Budgeting Fx Quotes Parity Theories Summation
Foreign Exchange Exposure • A measure of the potential for a firm’s – Profitability – Net cash flow – Market value of assets and liabilities to change because of a change in exchange rates • Objective to measure and manage these 3 parameters
Cross Border Risks • Cross Border Activities are exposed to risks – Political • Can affect short term as well as long term – Sovereign • Government not honoring commitments , country credit risk – Performance • Government not giving clearances or new unfavorable rules enforced – Payment • Customer not paying , unable or unwilling or disputing – Counter Party • One of the parties not honoring commitment – Liquidity • Assets cannot be sold at market prices or in a timely manner – Foreign Exchange or Currency Risk
Foreign Exchange or Currency Risk Whom does it affect? • Anyone with exposure to foreign currency – Exporters – Importers – Foreign Currency Borrowers /Lenders – Asset holders – Remittances to India – Remittances out of India – Others
Why do exchange rates change ? • Demand and Supply • Interest Rates • Flows into and out of the country • • • • Trade Flows Invisibles Investments (inbound and outbound) Borrowings/Lending • Political & Other Factors – Stability – Policies – Outlook • Speculation
How do changing exchange rates affect • A falling local currency – Increases cost of imports – Costlier servicing of foreign debt – Exports become more competitive – Investing outside India becomes more expensive • A rising local currency – Imports become cheaper – Cheaper servicing of foreign debt – Exports become less competitive – Investing outside India becomes cheaper
Objectives of Forex Risk Management • Protect Realizations/Outflows • Avoid or minimize negative surprises • Bring in more predictability • Capture opportunities • Stay competitive
Types of exposures • Transaction Exposure – Measures changes in the value of the outstanding financial obligations • Incurred or contracted before exchange rate change but not due to be settled till after the exchange rate change – Sensitivity of domestic currency value of foreign currency denominated costs and revenues • Economic Exposure – Also called operating, competitive or strategic exposure – Measures the change in PV of the firm resulting from changes in expected CF’s caused by unexpected changes in exchange rates • Translation Exposure – Also called accounting exposure – Potential for accounting derived changes in owner’s equity to occur because of the need to “translate” foreign currency financial statements of foreign subsidiaries for consolidated financial statements Currency Exposures do not always result in losses to the firm – Not due to firm’s true operations or core competence – But from timing associated with exchange rate changes and currency movements
Comparison of the 3 exposures Moment in time when exchange rate changes Transaction Exposure Economic Exposure Translation Exposure Time
Defining Hedging • Value of the firm – NPV of all expected future cash flows • One element of financial risk management – Exchange rate or Currency rate changes • Currency Risk – Variance in expected cash flows arising from unexpected exchange rate changes • Hedging – Taking of a position that will rise or fall to offset the fall or rise of an existing position – Attempts to reduce risk , not add value or return – Hedging not “free”
Arguments to hedge or not • Shareholders are capable of diversifying currency risk better • CRM does not increase the expected cash flow of the firm • Hedging benefits managers rather than SH (agency problem) • Managers cannot outguess market • Improves planning capability of the firm • Reduces risk of CF falling below a necessary minimum • Management knows currency risk better • Management is better aware of “disequilibrium” factors in market and can take advantage of the same through “selective hedging”
Transaction Exposure A more detailed look
Transaction Exposure – How does it arise • Purchasing or selling of goods where prices are stated in foreign currencies • Borrowing or lending in foreign currencies • Being a party to an unperformed foreign exchange forward contract • Acquiring assets or incurring liabilities denominated in foreign currencies
Basic question • An Indian company has – – – – payables of $ 10,000 for inputs due in one month, receivables of € 10,000 due in two months. The current exchange rate is Rs 43/ USD and Rs 55/ €. The expected spot rate on the date of payment is Rs 44/ $, and Rs 56/ € What is the cash outflow and inflow in rupees on the maturity date, if the actual spot rate on that day is identical to the expected spot rate. Is the transaction exposure favorable or unfavorable?
A simple costing example • I want to manufacture a product in India and sell to a customer in USA – I can produce 1 unit at Rs 1,50,000 – I want a profit margin of Rs 15,000 – I therefore need a selling price of Rs 1,65,000 • My customer is in USA and needs a price quoted in USD. – I therefore need to calculate my Rs 1,65,000 in USD and quote to him. • What do I do: Divide Rs 1,65,000 by the $ exchange rate of Rs 55 (on that date) and quote $3,000 to the customer • But, I want my money eventually converted back to INR when I receive payment from him .
What happens after that? • I now have an export order at $ 3,000 on hand , on which I expect / target to get Rs 1,65,000 • I need to Buy-Store-Process-Store-Ship-Collect • USD may not be Rs 55/ $ on the date of realization • If it goes to Rs 60/$, I gain – Because I now get $3,000 *60 =Rs 1,80,000 • If it goes to Rs 40/$,I lose – Because I now get $3,000 *40 =Rs 1,20,000
A typical transaction exposure Seller quotes Buyer orders Quotation Exposure Seller ships Backlog Exposure Buyer pays Billing Exposure
Borrowing and Lending - Example • I borrow $ 1.0 Million from a US bank to buy some equipment in India with a repayment after 3 years • On the day of receiving the $ , I give it to my bank and convert it into INR at 45.00/$ , I get Rs 45 Million • I pay my supplier in India Rs 45 Million and get my equipment • After 3 years ,USD/INR has moved to Rs 60.00 • I now need Rs 60 Million to buy $ 1.000 Million and repay my loan • Questions: Who runs a risk ?
01/Jan/93 01/Jan/94 01/Jan/95 01/Jan/96 01/Jan/97 01/Jan/98 01/Jan/99 01/Jan/00 01/Jan/01 01/Jan/02 01/Jan/03 01/Jan/04 01/Jan/05 01/Jan/06 01/Jan/07 01/Jan/08 01/Jan/09 01/Jan/10 01/Jan/11 01/Jan/12 01/Jan/13 USD/INR 70.00 65.00 60.00 55.00 50.00 45.00 40.00 35.00 30.00
USD/INR 70.00 69.50 69.00 68.50 68.00 67.50 67.00 66.50 66.00 65.50 65.00 64.50 64.00 63.50 63.00 62.50 62.00 61.50 61.00 60.50 60.00 59.50 59.00 58.50 58.00 57.50 57.00 56.50 56.00 55.50 55.00 54.50 54.00 53.50 53.00 52.50 52.00 51.50 51.00 50.50 50.00
What happens when • • • • • • • RBI signals reduction in interest rates US announces a likely curb on outsourcing An EU country reports serious problems China expected to grow faster India announces reduced tax on equity gains Key political ally withdraws support Likely downgrade of US by Rating agencies
Same Data , Different Analysis CRISIL & BOA - Appreciation Std Chartered - Depreciation • Capital inflows will resume because QE threat recedes and GOI promises reforms • CAD softens and expected to fall to 4.5% • However, there will be volatility in the path • BOA ML feels GOI/RBI will try to defend Rs 60/$ • Reform prospects are bleak and investors likely to get jittery • NRI bonds likely to have only short term impact • RBI unwilling to take on currency risk on such bonds • Trade deficit direction looks +ve • Gold imports and improved scenario in markets abroad • Need for much needed and reforms in natural gas, FDI policy and insurance / pension reforms – Sees it peaking at 59-60 – RBI will try for 54-58 if Euro trades between 1.30 to 1.20
What do I do ? 61? 56? 59
Background • In March 2007, the CFO of an Indian IT major stated that – ‘a 1% change in the rupee– dollar rate will have a fifty basis point impact on the margins’ – Impacts vary from company to company , directly or indirectly • Companies cannot afford to – sit on the sidelines and allow exchange rate volatility to ravage their bottom lines and balance sheets. – they adopt a proactive approach and use a variety of methods. • Hedge through contractual & non contractual methods – Requires the balancing of costs versus benefits
Profit Motive Philosophy of Risk Management Selective Hedging Speculate All Risks Hedged All Risks Open Risk Appetite
Managing Risk - Steps Identify Risk Review & Rebalance Probability Impact Hedge or not ? Partial or fully Contractual or NC Natural hedges Corporate philosophy Hedging Strategy & Alternatives Quantify Risk Set Risk Strategy
Scenarios • Sure of $/Rupee direction – Confident of upper/lower expected level – Not confident of upper/lower expected level • Unsure of $/Rupee direction • Known Exposure • Unknown Exposure • The Dilemma : Should I cover or not?
What should we do? • Depends on individual business/contract characteristics • Pricing models • Competitive pressures – From within India – From outside India –where is your competition? • Risk taking capacity/appetite • “Hindsight” factor !
Techniques used • • • • • • • • • Forwards or Futures Money Market Hedge Currency Option Hedge Leading & Lagging Cross Hedging Choice of Currency Currency Diversification Nontraditional Hedging Techniques Stay un-hedged
Forward Covers • A forward exchange contract is an agreement to exchange currencies at a future date at a precontracted exchange rate. • We contract to buy or sell $ ( for example) at a particular rate at a particular time in future – Could be a fixed date or a period – Currency where we want to hedge • Banks normally quote for up to 1 year forward • Forward rates may be higher or lower than the spot rate • Once booked , they are binding on us
22 Oct 2013 Rs/USD @ 9.33.36 am Bid (Exporter) Ask (Importer) Spot 61.80 61.82 Oct 61.92 61.96 Nov 62.37 62.41 Dec 62.85 62.90 Jan 63.31 63.37 Feb 63.68 63.74 Mar 64.05 64.11 Apr 64.52 64.58 May 64.86 64.92 Jun 65.22 65.28 Jul 65.58 65.64 Aug 65.90 65.96 Sep 66.25 66.31
Forward Covers – We lock in to a rate , for a future maturity date , for a specified $ amount – Example • Spot rate on 22 Oct 2013 = Rs 61.80/82 • Forward premium till April 2014 = Rs 2.72/2.76 • Assume Bank Charges = Rs0.03 • Forward rate for April 2014 for an exporter – 61.80+2.72-0.03 = 64.49 • Forward rate for April 2014 for an importer – 61.82+2.76+0.03 = 64.61 – On April 30 2014 , whether spot is Rs 50.00 or Rs 70.00, an exporter sells $ at Rs 64.49 and an importer buys $ at Rs 64.61 – We can cover for a date • (example :April 30th ) – We can cover for a period • (example : April 1st to April 30th ) .
Hedging of Forwards • In most foreign exchange markets , the spot market is more liquid than forwards – Standard and non standard maturities • Banks may face 2 risks till squaring off – A change in spot rate (bigger risk) – A change in forward margin (may be done later by some banks sometimes) • Long term hedges • Non dollar quotes
Advantages /Disadvantages of a cover • We have a fixed rate for $ for the future date • Brings in predictability to the future earnings / outflows • We lose potential gains above (exporter)/below (importer) forward cover rates • You have to deliver on the date or cancel or rollover – Risk of underlying transaction not happening /delayed • Changes in RBI policies ? !
Some other practical aspects • Running account (past performance based) versus order based availment • Branch or Treasury Desk • Level of automation at the bank/interface • Export Bill Discounting • Import Bill Acceptance • At sight and with credit • Discounting and collection basis • Through bank and documents in trust • Advance payments • EEFC account
Forwards & Futures Forwards • Flexible amount • Flexible maturity • OTC phone/fax/mail • Settlement or honoring normally by delivery • Counter party risk may exist Futures • Standard amount • Standard maturity • On exchanges ,same price • Settlement or honoring normally by cash settlement • Counter party risk lower due to MTM corrections
Scenarios • Sure of $/Rupee direction – Confident of upper/lower expected level – Not confident of upper/lower expected level • Unsure of $/Rupee direction • Known Exposure • Unknown Exposure • The Dilemma : Should I cover or not?
Money Market Hedge • Transaction exposure can also be hedged by lending or borrowing in the domestic and foreign money markets – Lend to hedge ? – Borrow to hedge ? • • • • What have we achieved by doing so ? What can be constraints to do so ? What else do we need to consider ? When will forwards be better than MMH ?
Example of a money market hedge • • • • • • • • • • • I have a receivable of $1,000,000 Current spot rate : Rs 43 INR interest rate 9 % , US interest rate 3% Step 1 : Borrow $ 970874 (1,000,000/1.03) Step 2 : Convert $970874 into INR Step 3: Receive Rs 41.748 Mio Step 4: Invest 41.748 Mio @ 9 % Step 5: Receive 45.505 Mio at maturity Step 6 : Customer pays me $ 1.000 Mio receivable Step 7 : Use that $1.000 Mio to repay Step 1 loan Step 8: I now have 45.505 Mio rupees left with me • WHAT FACTORS DO WE NEED TO CONSIDER TO CHOOSE THIS ?
Indian Context • Regular working capital borrowings • Export packing credit in INR • Pre shipment credit in Foreign Currency (LIBOR based rates) • Export Bill Discounting
Options – How is it different from a forward cover • As the name suggests , it gives the buyer of the option , an option without an obligation • On the future date, you can decide whether or not you want to use the option contract that you bought • This is useful when you want to protect a rate but also feel that there is potential for further gain in the $/Rupee equation
Parties to an option contract • Writer or seller of the option : The party who has an obligation to buy/sell the asset underlying the contract ,at the agreed price and time , if the option is exercised by the buyer of the option • Buyer of the option : The party who has the right but not the obligation to sell/buy the asset underlying the contract at the agreed price and time
Types of options • Call Option : The right , without the obligation, to buy an asset • Put Option : The right , without the obligation, to sell an asset • American Option : An option , which can be exercised at any time until the expiry date • European Option : An option , which can be exercised only on expiry • Bermudan Option : An option , which can be exercised only during a predefined portion of its life
What do we do ? CALL PUT BUY CALL SELL CALL BUY PUT SELL PUT BUY SELL
Expiry • Expiry : The last date on which the option may be exercised • Expiration time : Specified in the contract . Current practice generally specifies it as 10am New York time or 3pm Tokyo time
Exercise or Strike Price • Exercise or Strike Price : The specified price at which the buyer of the contract can exercise his right to buy or sell the asset • At-The-Money (ATM) : An option with a strike price equal to the current price of the asset. In currency terms , this can refer to the current spot rate (ATM spot) or the forward rate for the expiry date (ATM forward) • In-The-Money (ITM) : The strike price is more favorable to the buyer than the current market rate. Premium will be higher than in ATM • Out-Of The-Money (OTM) : The strike price is less favorable to the buyer than the current market rate. Premium will be lower than in ATM
Value/Price of an option • Option Premium : Fee or price paid by the buyer of the option to the seller of the option • Value of an option : The market price of the option • Intrinsic Value : The difference between the strike price and the current market exchange rate , in the case of an American style option it is profit available on immediate exercise. • Time Value : The difference between option premium and intrinsic value reflecting the value arising from time left until its expiry
How do options in Fx Work? – When an exporter buys a USD put option , he has the right ,but no obligation to sell USD at the “strike” price • For example , if he bought an option at a strike price of Rs 60 for April 2014, he can sell USD at 60 if the USD is below Rs 60 on due date • If it is above Rs 60,he can ignore his option and sell in the market at a higher price • His only cost is the option premium he paid – Some people buy and sell options to reduce cost • can work better than forwards if understood well • but that can be very risky if done without knowledge!
Simple Option - example • I want to protect an expected outflow of $ 1 Million using an option • Data as on date – Spot price Rs 60.00 – Forward Rate after 6 months 62.00 – Strike rate requested for 62.00 – Option premium (price) quoted by bank 1.00 • Let’s discuss these #’s first
I now own an option • I have spent Rs 1.00 *$ 1 Mio = Rs 1.000 Mio • I have the right to buy USD 1 Mio at Rs 62.00 • What happens after 6 months – If USD is > 62.00 , I will exercise my option – If USD is <62.00 , I will ignore my option (let it lapse) (I will not exercise it) • How is this different from a forward cover ?
Payoffs Call Option Option Fwd Cover - 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 56 57 58 59 60 61 62 63 64 65 66 67 68
Payoffs Put Option Option Fwd Cover - 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 56 57 58 59 60 61 62 63 64 65 66 67 68
Leading & Lagging • Operational technique to reduce transaction exposure • Lead – pay or collect early • Lag – pay or collect late • Which will we lead and which will we lag ? • A word of caution – why will counter party want to do so ? – will it affect business model or relations ? – Original invoice price already made assumptions • Can be used effectively between “related” parties
Cross Hedging • Method used when the currency in question cannot be hedged directly or cost effectively • Also called a proxy hedge because the currency chosen for hedging serves as a proxy for target currency • What will the effectiveness of this depend on? • What are the risks ?
Currency Diversification • Can limit the impact of a single currency movement • MNC’s may have this advantage being in different countries • How could smaller companies manage this ? • What basic characteristic is required between currencies for this strategy to be effective as a hedge ?
Choice of currency • Choosing which currency you would like your billing in ? • Scope may be limited especially where you do not call the shots in the relationship
Scenarios & what would you prefer • Basic Data – Spot 61.80/82 – March Forwards 64.05/11 • Your views as of now about March likelihood – Confident it will go above 65.00 – Confident it will stay steady at around 62.00 – Confident it will go below 60.00 – Confident Re will depreciate but not sure (63-70) – Not sure of direction (55-68)
Payoffs Call Option Option Fwd Cover - 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 56 57 58 59 60 61 62 63 64 65 66 67 68
Variations of simple options • Achieved through combining more than one option ,usually buying and selling options • Motives could be to : – Reduce or eliminate option premium – Achieve a different target range • Involve giving up “potential gains “ to achieve “savings in up front costs”
Payoff of the range forward option Eff Rate 51.5 51 50.5 50 49.5 49 48.5 48 47.5 47 46.5 Eff Rate 45 46 47 48 49 50 51 52 53 54 55 56 57
Range Forward • Also called a tunnel option • Example: – We want to hedge a $100 payable • Buy a call option @ 51.00 strike price : pay a premium of Rs 0.70 p • Sell a put option @ 48.00 strike price : receive same premium of Rs 0.70 p – On expiry • If spot is 53.00 , we exercise at 51.00 • If spot is less than 48.00 , buyer of option exercises at 48.00
Ratio Range Forward • If end user wants a better rate for the bought option – say 49.00 instead of 51.00 in earlier example • He will have to give up something – Either pay a higher premium • (1.55 vs 0.70 earlier example) OR – He will need to sell more options • 3.1 puts at 47.00 vs 1 put at 48.00 earlier example • Now , let’s look at payoffs
What happens at expiry • If spot rate is above 49.00 , call purchased will be exercised • Between 47 & 49 , neither will be exercised • If spot is below 47.00 , (say 46) , put of 310$ will be exercised by counter party • We need only $100 so we will have to sell $210 at spot rate (46.00) and receive 9660 • Effective cost 49.10 (310*47 -9660)= 4910 • 4910/100 =49.10
Payoff of the ratio range forward Eff Rate 52.00 51.00 50.00 49.00 48.00 Eff Rate 47.00 46.00 45.00 44.00 45 46 47 48 49 50 51 52
Payoff of the participating forward 33% participation 50.50 50.00 49.50 49.00 48.50 48.00 47.50 45 46 47 48 49 50 51 52
Participating Forward • Combination of forward contract and option – Forward rate on that day 49.38 – Price of 50 put 1.87 – Gap of 62 p used to buy a put option for 1/3rd of the contract • If spot on expiry is 46 , put option will be exercised with a profit of Rs 4 – Gain 4*1/3 =1.33 – Our effective cost of buying $ = 48.67 • Larger the participation required, greater will be the rate !
Payoff of the seagull 0.80 0.60 0.40 0.20 (0.20) (0.40) (0.60) (0.80) (1.00) (1.20) 46 47 48 49 50 51 52
Seagull Option • A zero cost structure but more complicated than simple range forward – Buy call @ 50.00 (1.40 outflow) – Sell put @ 47.00(0.50 inflow) – Sell call @ 50.70 (0.90 inflow) • If spot 50-50.70 , call option we bought will be exercised but not the call sold • If spot > 50.70, both calls will be exercised and payoff stabilizes at 0.70p – Actual cost = (spot-0.70) • Gets its name from payoff graph
Choices & Considerations • • • • • • Forward contracts versus Money Market Forward contracts versus Options Forward contracts versus not hedging Options versus not hedging Options versus money markets What do we do when there are timing mismatches • What do we do when there is uncertainty regarding timing of inflows and outflows
Economic Exposure • Also called operating exposure, competitive exposure and sometimes strategic exposure • Measures any change in the PV of the firm resulting from changes in future operating CF caused by any unexpected changes in exchange rates • Goal is to identify strategies or techniques that will enhance value in the face of unexpected exchange rate changes
Economic / Operating Exposure • Depends on – – – – Change in nominal exchange rate Change in the selling price (output price) Change in the quantity of output sold Change in operating costs (quantities & input price) • Impact of real exchange rates • Combination of 2 effects – Conversion Effect – Competitive Effect
Factors that influence • • • • • Geographical extent of market Who are the dominant players Market power & demand elasticity Impact on input prices Currency composition of operating costs
Attributes of Economic Exposure • Requires forecasting and analyzing firm’s – future individual transaction exposures – future exposures of competitors ,present and likely • Analysis of longer term than transaction exposure – Transaction exposures – Anticipated transaction exposures – Longer term exposures
Operating & Financial Cash Flows • Operating cash flows arise from – Intercompany & Intra-company receivables & payables , rent , royalties, license fees , management fees • Financial cash flows arise from – Payments for loans • Principal & Interest – Equity related • Equity investments & Dividends
Expected versus Unexpected changes in Cash Flow • Economic Exposure is far more important for long term health of the business • Subjective - estimation over long time horizon • Not from accounting process –total management responsibility – all functions • Only unexpected changes should cause changes --- why ? • Macroeconomic uncertainty
Strategic management of Economic exposure • Objective of transaction & economic exposure management – Anticipate and influence the effect of unexpected changes in exchange rates on a firm’s future cash flows • To meet this objective, firms can – Diversify the firm’s operating base – Diversify the firm’s financing base – Change the firm’s operating and financial policies
Proactive management of economic exposure • • • • • • • Matching currency cash flows Risk sharing agreements Back to back or parallel loans Currency Swaps Leads & Lags Reinvoicing Centres Contractual approaches
How is it different from transaction exposure • Transaction exposure – exchange rate risk on converting inflows or outflows • Economic exposure – any impact of exchange rate fluctuations on a firm’s cash flow – More far reaching and encompassing than transaction exposure – May need strategic moves and changes
STEPS IN MANAGING ECONOMIC EXPOSURE • 1. Estimation of planning horizon • 2. Determination of expected future spot rate. • 3. Estimation of expected revenue and cost streams, given the expected spot rate. • 4. Estimation of effect on revenue and expense streams for unexpected exchange rate changes. • 5. Choice of appropriate currency for debt denomination. • 6. Estimation of necessary amount of foreign currency debt. • 7. Determination of average interest period of debt. • 8. Selection debt denomination. • 9. Decision on trade-off from exposure in markets where rates are distorted by controls. • 10. Decision about "residual" risk: business strategy.
Possible strategies to hedge economic exposure • • • • • • Pricing Import or Export strategy Relocation or Multi Location Financing Closure or Hiving Off Long Term Hedging
Translation Exposure Some aspects and methods
Translation Exposure • Also called accounting exposure • Arises because financial statements of foreign subsidiaries must be restated to parent’s reporting currency • Potential for an increase/decrease in parent’s net worth due to exchange rate changes • Also used to evaluate subsidiary performance
Overview of translation • Foreign currency financial statements restated • Different exchange rates for different line items – Historic & Current • Methods differ based on – Level of independence • Integrated foreign entity • Self sustaining foreign entity – Which currency is most important for subsidiary • Dominant currency day to day
Corporate Risk Management System • Issues to be addressed – Strategic business posture – Attitude towards risk – Risk tolerance – Organizational design – Monitoring & Control mechanisms – Performance evaluation – Conflicts of interest and resolution mechanisms

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7.international finance exposures

  • 1.
  • 2.
    Our Road Map Introduction& Overview Managing currency risks Raising Funds Abroad or in Fx Opportunities & Risks BOP Understanding Currency Exposures & Risk Managing the risks Fx Markets Exchange Rate Determination & Forecasting Capital Budgeting Fx Quotes Parity Theories Summation
  • 3.
    Foreign Exchange Exposure •A measure of the potential for a firm’s – Profitability – Net cash flow – Market value of assets and liabilities to change because of a change in exchange rates • Objective to measure and manage these 3 parameters
  • 4.
    Cross Border Risks •Cross Border Activities are exposed to risks – Political • Can affect short term as well as long term – Sovereign • Government not honoring commitments , country credit risk – Performance • Government not giving clearances or new unfavorable rules enforced – Payment • Customer not paying , unable or unwilling or disputing – Counter Party • One of the parties not honoring commitment – Liquidity • Assets cannot be sold at market prices or in a timely manner – Foreign Exchange or Currency Risk
  • 5.
    Foreign Exchange orCurrency Risk Whom does it affect? • Anyone with exposure to foreign currency – Exporters – Importers – Foreign Currency Borrowers /Lenders – Asset holders – Remittances to India – Remittances out of India – Others
  • 6.
    Why do exchangerates change ? • Demand and Supply • Interest Rates • Flows into and out of the country • • • • Trade Flows Invisibles Investments (inbound and outbound) Borrowings/Lending • Political & Other Factors – Stability – Policies – Outlook • Speculation
  • 7.
    How do changingexchange rates affect • A falling local currency – Increases cost of imports – Costlier servicing of foreign debt – Exports become more competitive – Investing outside India becomes more expensive • A rising local currency – Imports become cheaper – Cheaper servicing of foreign debt – Exports become less competitive – Investing outside India becomes cheaper
  • 8.
    Objectives of ForexRisk Management • Protect Realizations/Outflows • Avoid or minimize negative surprises • Bring in more predictability • Capture opportunities • Stay competitive
  • 9.
    Types of exposures •Transaction Exposure – Measures changes in the value of the outstanding financial obligations • Incurred or contracted before exchange rate change but not due to be settled till after the exchange rate change – Sensitivity of domestic currency value of foreign currency denominated costs and revenues • Economic Exposure – Also called operating, competitive or strategic exposure – Measures the change in PV of the firm resulting from changes in expected CF’s caused by unexpected changes in exchange rates • Translation Exposure – Also called accounting exposure – Potential for accounting derived changes in owner’s equity to occur because of the need to “translate” foreign currency financial statements of foreign subsidiaries for consolidated financial statements Currency Exposures do not always result in losses to the firm – Not due to firm’s true operations or core competence – But from timing associated with exchange rate changes and currency movements
  • 10.
    Comparison of the3 exposures Moment in time when exchange rate changes Transaction Exposure Economic Exposure Translation Exposure Time
  • 11.
    Defining Hedging • Valueof the firm – NPV of all expected future cash flows • One element of financial risk management – Exchange rate or Currency rate changes • Currency Risk – Variance in expected cash flows arising from unexpected exchange rate changes • Hedging – Taking of a position that will rise or fall to offset the fall or rise of an existing position – Attempts to reduce risk , not add value or return – Hedging not “free”
  • 12.
    Arguments to hedgeor not • Shareholders are capable of diversifying currency risk better • CRM does not increase the expected cash flow of the firm • Hedging benefits managers rather than SH (agency problem) • Managers cannot outguess market • Improves planning capability of the firm • Reduces risk of CF falling below a necessary minimum • Management knows currency risk better • Management is better aware of “disequilibrium” factors in market and can take advantage of the same through “selective hedging”
  • 13.
  • 14.
    Transaction Exposure –How does it arise • Purchasing or selling of goods where prices are stated in foreign currencies • Borrowing or lending in foreign currencies • Being a party to an unperformed foreign exchange forward contract • Acquiring assets or incurring liabilities denominated in foreign currencies
  • 15.
    Basic question • AnIndian company has – – – – payables of $ 10,000 for inputs due in one month, receivables of € 10,000 due in two months. The current exchange rate is Rs 43/ USD and Rs 55/ €. The expected spot rate on the date of payment is Rs 44/ $, and Rs 56/ € What is the cash outflow and inflow in rupees on the maturity date, if the actual spot rate on that day is identical to the expected spot rate. Is the transaction exposure favorable or unfavorable?
  • 16.
    A simple costingexample • I want to manufacture a product in India and sell to a customer in USA – I can produce 1 unit at Rs 1,50,000 – I want a profit margin of Rs 15,000 – I therefore need a selling price of Rs 1,65,000 • My customer is in USA and needs a price quoted in USD. – I therefore need to calculate my Rs 1,65,000 in USD and quote to him. • What do I do: Divide Rs 1,65,000 by the $ exchange rate of Rs 55 (on that date) and quote $3,000 to the customer • But, I want my money eventually converted back to INR when I receive payment from him .
  • 17.
    What happens afterthat? • I now have an export order at $ 3,000 on hand , on which I expect / target to get Rs 1,65,000 • I need to Buy-Store-Process-Store-Ship-Collect • USD may not be Rs 55/ $ on the date of realization • If it goes to Rs 60/$, I gain – Because I now get $3,000 *60 =Rs 1,80,000 • If it goes to Rs 40/$,I lose – Because I now get $3,000 *40 =Rs 1,20,000
  • 18.
    A typical transactionexposure Seller quotes Buyer orders Quotation Exposure Seller ships Backlog Exposure Buyer pays Billing Exposure
  • 19.
    Borrowing and Lending- Example • I borrow $ 1.0 Million from a US bank to buy some equipment in India with a repayment after 3 years • On the day of receiving the $ , I give it to my bank and convert it into INR at 45.00/$ , I get Rs 45 Million • I pay my supplier in India Rs 45 Million and get my equipment • After 3 years ,USD/INR has moved to Rs 60.00 • I now need Rs 60 Million to buy $ 1.000 Million and repay my loan • Questions: Who runs a risk ?
  • 20.
  • 21.
  • 22.
    What happens when • • • • • • • RBIsignals reduction in interest rates US announces a likely curb on outsourcing An EU country reports serious problems China expected to grow faster India announces reduced tax on equity gains Key political ally withdraws support Likely downgrade of US by Rating agencies
  • 23.
    Same Data ,Different Analysis CRISIL & BOA - Appreciation Std Chartered - Depreciation • Capital inflows will resume because QE threat recedes and GOI promises reforms • CAD softens and expected to fall to 4.5% • However, there will be volatility in the path • BOA ML feels GOI/RBI will try to defend Rs 60/$ • Reform prospects are bleak and investors likely to get jittery • NRI bonds likely to have only short term impact • RBI unwilling to take on currency risk on such bonds • Trade deficit direction looks +ve • Gold imports and improved scenario in markets abroad • Need for much needed and reforms in natural gas, FDI policy and insurance / pension reforms – Sees it peaking at 59-60 – RBI will try for 54-58 if Euro trades between 1.30 to 1.20
  • 24.
    What do Ido ? 61? 56? 59
  • 25.
    Background • In March2007, the CFO of an Indian IT major stated that – ‘a 1% change in the rupee– dollar rate will have a fifty basis point impact on the margins’ – Impacts vary from company to company , directly or indirectly • Companies cannot afford to – sit on the sidelines and allow exchange rate volatility to ravage their bottom lines and balance sheets. – they adopt a proactive approach and use a variety of methods. • Hedge through contractual & non contractual methods – Requires the balancing of costs versus benefits
  • 26.
    Profit Motive Philosophy ofRisk Management Selective Hedging Speculate All Risks Hedged All Risks Open Risk Appetite
  • 27.
    Managing Risk -Steps Identify Risk Review & Rebalance Probability Impact Hedge or not ? Partial or fully Contractual or NC Natural hedges Corporate philosophy Hedging Strategy & Alternatives Quantify Risk Set Risk Strategy
  • 28.
    Scenarios • Sure of$/Rupee direction – Confident of upper/lower expected level – Not confident of upper/lower expected level • Unsure of $/Rupee direction • Known Exposure • Unknown Exposure • The Dilemma : Should I cover or not?
  • 29.
    What should wedo? • Depends on individual business/contract characteristics • Pricing models • Competitive pressures – From within India – From outside India –where is your competition? • Risk taking capacity/appetite • “Hindsight” factor !
  • 30.
    Techniques used • • • • • • • • • Forwards orFutures Money Market Hedge Currency Option Hedge Leading & Lagging Cross Hedging Choice of Currency Currency Diversification Nontraditional Hedging Techniques Stay un-hedged
  • 31.
    Forward Covers • Aforward exchange contract is an agreement to exchange currencies at a future date at a precontracted exchange rate. • We contract to buy or sell $ ( for example) at a particular rate at a particular time in future – Could be a fixed date or a period – Currency where we want to hedge • Banks normally quote for up to 1 year forward • Forward rates may be higher or lower than the spot rate • Once booked , they are binding on us
  • 32.
    22 Oct 2013Rs/USD @ 9.33.36 am Bid (Exporter) Ask (Importer) Spot 61.80 61.82 Oct 61.92 61.96 Nov 62.37 62.41 Dec 62.85 62.90 Jan 63.31 63.37 Feb 63.68 63.74 Mar 64.05 64.11 Apr 64.52 64.58 May 64.86 64.92 Jun 65.22 65.28 Jul 65.58 65.64 Aug 65.90 65.96 Sep 66.25 66.31
  • 33.
    Forward Covers – Welock in to a rate , for a future maturity date , for a specified $ amount – Example • Spot rate on 22 Oct 2013 = Rs 61.80/82 • Forward premium till April 2014 = Rs 2.72/2.76 • Assume Bank Charges = Rs0.03 • Forward rate for April 2014 for an exporter – 61.80+2.72-0.03 = 64.49 • Forward rate for April 2014 for an importer – 61.82+2.76+0.03 = 64.61 – On April 30 2014 , whether spot is Rs 50.00 or Rs 70.00, an exporter sells $ at Rs 64.49 and an importer buys $ at Rs 64.61 – We can cover for a date • (example :April 30th ) – We can cover for a period • (example : April 1st to April 30th ) .
  • 34.
    Hedging of Forwards •In most foreign exchange markets , the spot market is more liquid than forwards – Standard and non standard maturities • Banks may face 2 risks till squaring off – A change in spot rate (bigger risk) – A change in forward margin (may be done later by some banks sometimes) • Long term hedges • Non dollar quotes
  • 35.
    Advantages /Disadvantages ofa cover • We have a fixed rate for $ for the future date • Brings in predictability to the future earnings / outflows • We lose potential gains above (exporter)/below (importer) forward cover rates • You have to deliver on the date or cancel or rollover – Risk of underlying transaction not happening /delayed • Changes in RBI policies ? !
  • 36.
    Some other practicalaspects • Running account (past performance based) versus order based availment • Branch or Treasury Desk • Level of automation at the bank/interface • Export Bill Discounting • Import Bill Acceptance • At sight and with credit • Discounting and collection basis • Through bank and documents in trust • Advance payments • EEFC account
  • 37.
    Forwards & Futures Forwards •Flexible amount • Flexible maturity • OTC phone/fax/mail • Settlement or honoring normally by delivery • Counter party risk may exist Futures • Standard amount • Standard maturity • On exchanges ,same price • Settlement or honoring normally by cash settlement • Counter party risk lower due to MTM corrections
  • 38.
    Scenarios • Sure of$/Rupee direction – Confident of upper/lower expected level – Not confident of upper/lower expected level • Unsure of $/Rupee direction • Known Exposure • Unknown Exposure • The Dilemma : Should I cover or not?
  • 39.
    Money Market Hedge •Transaction exposure can also be hedged by lending or borrowing in the domestic and foreign money markets – Lend to hedge ? – Borrow to hedge ? • • • • What have we achieved by doing so ? What can be constraints to do so ? What else do we need to consider ? When will forwards be better than MMH ?
  • 40.
    Example of amoney market hedge • • • • • • • • • • • I have a receivable of $1,000,000 Current spot rate : Rs 43 INR interest rate 9 % , US interest rate 3% Step 1 : Borrow $ 970874 (1,000,000/1.03) Step 2 : Convert $970874 into INR Step 3: Receive Rs 41.748 Mio Step 4: Invest 41.748 Mio @ 9 % Step 5: Receive 45.505 Mio at maturity Step 6 : Customer pays me $ 1.000 Mio receivable Step 7 : Use that $1.000 Mio to repay Step 1 loan Step 8: I now have 45.505 Mio rupees left with me • WHAT FACTORS DO WE NEED TO CONSIDER TO CHOOSE THIS ?
  • 41.
    Indian Context • Regularworking capital borrowings • Export packing credit in INR • Pre shipment credit in Foreign Currency (LIBOR based rates) • Export Bill Discounting
  • 42.
    Options – Howis it different from a forward cover • As the name suggests , it gives the buyer of the option , an option without an obligation • On the future date, you can decide whether or not you want to use the option contract that you bought • This is useful when you want to protect a rate but also feel that there is potential for further gain in the $/Rupee equation
  • 43.
    Parties to anoption contract • Writer or seller of the option : The party who has an obligation to buy/sell the asset underlying the contract ,at the agreed price and time , if the option is exercised by the buyer of the option • Buyer of the option : The party who has the right but not the obligation to sell/buy the asset underlying the contract at the agreed price and time
  • 44.
    Types of options •Call Option : The right , without the obligation, to buy an asset • Put Option : The right , without the obligation, to sell an asset • American Option : An option , which can be exercised at any time until the expiry date • European Option : An option , which can be exercised only on expiry • Bermudan Option : An option , which can be exercised only during a predefined portion of its life
  • 45.
    What do wedo ? CALL PUT BUY CALL SELL CALL BUY PUT SELL PUT BUY SELL
  • 46.
    Expiry • Expiry :The last date on which the option may be exercised • Expiration time : Specified in the contract . Current practice generally specifies it as 10am New York time or 3pm Tokyo time
  • 47.
    Exercise or StrikePrice • Exercise or Strike Price : The specified price at which the buyer of the contract can exercise his right to buy or sell the asset • At-The-Money (ATM) : An option with a strike price equal to the current price of the asset. In currency terms , this can refer to the current spot rate (ATM spot) or the forward rate for the expiry date (ATM forward) • In-The-Money (ITM) : The strike price is more favorable to the buyer than the current market rate. Premium will be higher than in ATM • Out-Of The-Money (OTM) : The strike price is less favorable to the buyer than the current market rate. Premium will be lower than in ATM
  • 48.
    Value/Price of anoption • Option Premium : Fee or price paid by the buyer of the option to the seller of the option • Value of an option : The market price of the option • Intrinsic Value : The difference between the strike price and the current market exchange rate , in the case of an American style option it is profit available on immediate exercise. • Time Value : The difference between option premium and intrinsic value reflecting the value arising from time left until its expiry
  • 49.
    How do optionsin Fx Work? – When an exporter buys a USD put option , he has the right ,but no obligation to sell USD at the “strike” price • For example , if he bought an option at a strike price of Rs 60 for April 2014, he can sell USD at 60 if the USD is below Rs 60 on due date • If it is above Rs 60,he can ignore his option and sell in the market at a higher price • His only cost is the option premium he paid – Some people buy and sell options to reduce cost • can work better than forwards if understood well • but that can be very risky if done without knowledge!
  • 50.
    Simple Option -example • I want to protect an expected outflow of $ 1 Million using an option • Data as on date – Spot price Rs 60.00 – Forward Rate after 6 months 62.00 – Strike rate requested for 62.00 – Option premium (price) quoted by bank 1.00 • Let’s discuss these #’s first
  • 51.
    I now ownan option • I have spent Rs 1.00 *$ 1 Mio = Rs 1.000 Mio • I have the right to buy USD 1 Mio at Rs 62.00 • What happens after 6 months – If USD is > 62.00 , I will exercise my option – If USD is <62.00 , I will ignore my option (let it lapse) (I will not exercise it) • How is this different from a forward cover ?
  • 52.
    Payoffs Call Option Option FwdCover - 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 56 57 58 59 60 61 62 63 64 65 66 67 68
  • 53.
    Payoffs Put Option Option FwdCover - 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 56 57 58 59 60 61 62 63 64 65 66 67 68
  • 54.
    Leading & Lagging •Operational technique to reduce transaction exposure • Lead – pay or collect early • Lag – pay or collect late • Which will we lead and which will we lag ? • A word of caution – why will counter party want to do so ? – will it affect business model or relations ? – Original invoice price already made assumptions • Can be used effectively between “related” parties
  • 55.
    Cross Hedging • Methodused when the currency in question cannot be hedged directly or cost effectively • Also called a proxy hedge because the currency chosen for hedging serves as a proxy for target currency • What will the effectiveness of this depend on? • What are the risks ?
  • 56.
    Currency Diversification • Canlimit the impact of a single currency movement • MNC’s may have this advantage being in different countries • How could smaller companies manage this ? • What basic characteristic is required between currencies for this strategy to be effective as a hedge ?
  • 57.
    Choice of currency •Choosing which currency you would like your billing in ? • Scope may be limited especially where you do not call the shots in the relationship
  • 58.
    Scenarios & whatwould you prefer • Basic Data – Spot 61.80/82 – March Forwards 64.05/11 • Your views as of now about March likelihood – Confident it will go above 65.00 – Confident it will stay steady at around 62.00 – Confident it will go below 60.00 – Confident Re will depreciate but not sure (63-70) – Not sure of direction (55-68)
  • 59.
    Payoffs Call Option Option FwdCover - 7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 56 57 58 59 60 61 62 63 64 65 66 67 68
  • 60.
    Variations of simpleoptions • Achieved through combining more than one option ,usually buying and selling options • Motives could be to : – Reduce or eliminate option premium – Achieve a different target range • Involve giving up “potential gains “ to achieve “savings in up front costs”
  • 61.
    Payoff of therange forward option Eff Rate 51.5 51 50.5 50 49.5 49 48.5 48 47.5 47 46.5 Eff Rate 45 46 47 48 49 50 51 52 53 54 55 56 57
  • 62.
    Range Forward • Alsocalled a tunnel option • Example: – We want to hedge a $100 payable • Buy a call option @ 51.00 strike price : pay a premium of Rs 0.70 p • Sell a put option @ 48.00 strike price : receive same premium of Rs 0.70 p – On expiry • If spot is 53.00 , we exercise at 51.00 • If spot is less than 48.00 , buyer of option exercises at 48.00
  • 63.
    Ratio Range Forward •If end user wants a better rate for the bought option – say 49.00 instead of 51.00 in earlier example • He will have to give up something – Either pay a higher premium • (1.55 vs 0.70 earlier example) OR – He will need to sell more options • 3.1 puts at 47.00 vs 1 put at 48.00 earlier example • Now , let’s look at payoffs
  • 64.
    What happens atexpiry • If spot rate is above 49.00 , call purchased will be exercised • Between 47 & 49 , neither will be exercised • If spot is below 47.00 , (say 46) , put of 310$ will be exercised by counter party • We need only $100 so we will have to sell $210 at spot rate (46.00) and receive 9660 • Effective cost 49.10 (310*47 -9660)= 4910 • 4910/100 =49.10
  • 65.
    Payoff of theratio range forward Eff Rate 52.00 51.00 50.00 49.00 48.00 Eff Rate 47.00 46.00 45.00 44.00 45 46 47 48 49 50 51 52
  • 66.
    Payoff of theparticipating forward 33% participation 50.50 50.00 49.50 49.00 48.50 48.00 47.50 45 46 47 48 49 50 51 52
  • 67.
    Participating Forward • Combinationof forward contract and option – Forward rate on that day 49.38 – Price of 50 put 1.87 – Gap of 62 p used to buy a put option for 1/3rd of the contract • If spot on expiry is 46 , put option will be exercised with a profit of Rs 4 – Gain 4*1/3 =1.33 – Our effective cost of buying $ = 48.67 • Larger the participation required, greater will be the rate !
  • 68.
    Payoff of theseagull 0.80 0.60 0.40 0.20 (0.20) (0.40) (0.60) (0.80) (1.00) (1.20) 46 47 48 49 50 51 52
  • 69.
    Seagull Option • Azero cost structure but more complicated than simple range forward – Buy call @ 50.00 (1.40 outflow) – Sell put @ 47.00(0.50 inflow) – Sell call @ 50.70 (0.90 inflow) • If spot 50-50.70 , call option we bought will be exercised but not the call sold • If spot > 50.70, both calls will be exercised and payoff stabilizes at 0.70p – Actual cost = (spot-0.70) • Gets its name from payoff graph
  • 70.
    Choices & Considerations • • • • • • Forwardcontracts versus Money Market Forward contracts versus Options Forward contracts versus not hedging Options versus not hedging Options versus money markets What do we do when there are timing mismatches • What do we do when there is uncertainty regarding timing of inflows and outflows
  • 71.
    Economic Exposure • Alsocalled operating exposure, competitive exposure and sometimes strategic exposure • Measures any change in the PV of the firm resulting from changes in future operating CF caused by any unexpected changes in exchange rates • Goal is to identify strategies or techniques that will enhance value in the face of unexpected exchange rate changes
  • 72.
    Economic / OperatingExposure • Depends on – – – – Change in nominal exchange rate Change in the selling price (output price) Change in the quantity of output sold Change in operating costs (quantities & input price) • Impact of real exchange rates • Combination of 2 effects – Conversion Effect – Competitive Effect
  • 73.
    Factors that influence • • • • • Geographicalextent of market Who are the dominant players Market power & demand elasticity Impact on input prices Currency composition of operating costs
  • 74.
    Attributes of EconomicExposure • Requires forecasting and analyzing firm’s – future individual transaction exposures – future exposures of competitors ,present and likely • Analysis of longer term than transaction exposure – Transaction exposures – Anticipated transaction exposures – Longer term exposures
  • 75.
    Operating & FinancialCash Flows • Operating cash flows arise from – Intercompany & Intra-company receivables & payables , rent , royalties, license fees , management fees • Financial cash flows arise from – Payments for loans • Principal & Interest – Equity related • Equity investments & Dividends
  • 76.
    Expected versus Unexpectedchanges in Cash Flow • Economic Exposure is far more important for long term health of the business • Subjective - estimation over long time horizon • Not from accounting process –total management responsibility – all functions • Only unexpected changes should cause changes --- why ? • Macroeconomic uncertainty
  • 77.
    Strategic management ofEconomic exposure • Objective of transaction & economic exposure management – Anticipate and influence the effect of unexpected changes in exchange rates on a firm’s future cash flows • To meet this objective, firms can – Diversify the firm’s operating base – Diversify the firm’s financing base – Change the firm’s operating and financial policies
  • 78.
    Proactive management ofeconomic exposure • • • • • • • Matching currency cash flows Risk sharing agreements Back to back or parallel loans Currency Swaps Leads & Lags Reinvoicing Centres Contractual approaches
  • 79.
    How is itdifferent from transaction exposure • Transaction exposure – exchange rate risk on converting inflows or outflows • Economic exposure – any impact of exchange rate fluctuations on a firm’s cash flow – More far reaching and encompassing than transaction exposure – May need strategic moves and changes
  • 80.
    STEPS IN MANAGINGECONOMIC EXPOSURE • 1. Estimation of planning horizon • 2. Determination of expected future spot rate. • 3. Estimation of expected revenue and cost streams, given the expected spot rate. • 4. Estimation of effect on revenue and expense streams for unexpected exchange rate changes. • 5. Choice of appropriate currency for debt denomination. • 6. Estimation of necessary amount of foreign currency debt. • 7. Determination of average interest period of debt. • 8. Selection debt denomination. • 9. Decision on trade-off from exposure in markets where rates are distorted by controls. • 10. Decision about "residual" risk: business strategy.
  • 81.
    Possible strategies tohedge economic exposure • • • • • • Pricing Import or Export strategy Relocation or Multi Location Financing Closure or Hiving Off Long Term Hedging
  • 82.
  • 83.
    Translation Exposure • Alsocalled accounting exposure • Arises because financial statements of foreign subsidiaries must be restated to parent’s reporting currency • Potential for an increase/decrease in parent’s net worth due to exchange rate changes • Also used to evaluate subsidiary performance
  • 84.
    Overview of translation •Foreign currency financial statements restated • Different exchange rates for different line items – Historic & Current • Methods differ based on – Level of independence • Integrated foreign entity • Self sustaining foreign entity – Which currency is most important for subsidiary • Dominant currency day to day
  • 85.
    Corporate Risk ManagementSystem • Issues to be addressed – Strategic business posture – Attitude towards risk – Risk tolerance – Organizational design – Monitoring & Control mechanisms – Performance evaluation – Conflicts of interest and resolution mechanisms