L'efficienza del mercato - determinazione e collaudo Che cosa è un mercato efficace del mercato efficiente è quella in cui il prezzo di mercato è una stima imparziale del vero valore della partecipazione. Implicito in questa derivazione sono diversi concetti chiave - (a) l'efficienza del mercato non richiede che il prezzo di mercato sia pari al valore reale in ogni punto nel tempo. Tutto ciò che richiede è che gli errori del prezzo di mercato essere imparziale, vale a dire che i prezzi possono essere superiore o inferiore al valore vero, a patto che queste deviazioni sono casuali. (B) Il fatto che le deviazioni dal valore vero sono casuali implica, in un senso grezzo, che vi è una probabilità uguale che le scorte sono sopra o valutati in qualsiasi punto nel tempo, e che queste deviazioni sono correlate con qualsiasi variabile osservabile. Per esempio, in un mercato efficiente, titoli con rapporti PE minori non dovrebbero essere più o meno probabilità di sotto del valore di titoli con elevati rapporti di PE. (C) se le divergenze dei prezzi di mercato dal valore vero sono casuali, ne consegue che nessun gruppo di investitori dovrebbe essere in grado di trovare costantemente sotto o sopra le scorte valutate con qualsiasi strategia di investimento. Efficienza del mercato per gli investitori Gruppi definizioni di efficienza del mercato devono essere specifici, non solo per il mercato che viene presa in considerazione, ma anche il gruppo di investitori che è coperto. E 'estremamente improbabile che tutti i mercati sono efficienti a tutti gli investitori. ma è del tutto possibile che un mercato particolare (per esempio, il New York Stock Exchange) è efficiente rispetto alla investitore medio. È anche possibile che alcuni mercati sono efficienti, mentre altri non lo sono, e che un mercato è efficiente rispetto ad alcuni investitori e non ad altri. Questa è una conseguenza diretta delle aliquote fiscali differenziali e costi di transazione, che conferiscono vantaggi su alcuni investitori rispetto agli altri. Le definizioni di efficienza del mercato sono anche collegati con ipotesi su quali informazioni sono disponibili agli investitori e riflesse nel prezzo. Per esempio, una definizione rigorosa di efficienza del mercato che presuppone che tutte le informazioni, pubblico e privato, si riflette nei prezzi di mercato implicherebbe che anche gli investitori con precise informazioni privilegiate saranno in grado di battere il mercato. Forte contro Debole Efficienza Forma: - Sotto debole efficienza modulo. il prezzo corrente riflette le informazioni contenute in tutti i prezzi del passato, suggerendo che i grafici e le analisi tecniche che utilizzano passato i prezzi da soli non sarebbero utili nella ricerca di sotto delle scorte di valore. - Sotto semi-forte efficienza modulo. il prezzo corrente riflette le informazioni contenute non solo nei prezzi passati, ma tutte le informazioni pubbliche (incluse le relazioni finanziarie e notizie) e nessun approccio che si basava sull'uso e massaggiare queste informazioni sarebbero utili nella ricerca di sotto delle scorte di valore. - In forte efficienza modulo. il prezzo corrente riflette tutte le informazioni. pubbliche e private, e non gli investitori saranno in grado di trovare costantemente sotto le scorte di valore. Implicazioni di efficienza del mercato Una implicazione immediata e diretta di un mercato efficiente è che nessun gruppo di investitori dovrebbe essere in grado di battere costantemente il mercato con una strategia di investimento comune. Un mercato efficiente potrebbe anche portare conseguenze molto negative per molte strategie di investimento e azioni che vengono date per scontate - (a) In un mercato efficiente, ricerca azionaria e valutazione sarebbe un compito oneroso che ha fornito alcun beneficio. Le probabilità di trovare un magazzino sottovalutato dovrebbero essere casuale (5050). Nella migliore delle ipotesi, i benefici di raccolta di informazioni e ricerca azionaria avrebbero coperto i costi di fare la ricerca. (B) In un mercato efficiente, una strategia di diversificazione in modo casuale attraverso azioni o l'indicizzazione al mercato, portando il costo informazioni poca o nessuna e costi di esecuzione minimi, sarebbe superiore a qualsiasi altra strategia. che ha creato grandi costi di informazione e di esecuzione. Non ci sarebbe alcun valore aggiunto dai gestori di portafoglio e strateghi di investimento. (C) In un mercato efficiente, una strategia di minimizzazione di trading. la creazione cioè di un portafoglio e non la negoziazione a meno era necessario contanti, sarebbe superiore a una strategia che ha richiesto di trading frequente. Che l'efficienza del mercato non implica: un mercato efficiente non implica che - (a) i prezzi delle azioni non può deviare dal vero valore in effetti, ci possono essere grandi deviazioni dal valore vero. L'unico requisito è che le deviazioni essere casuali. (B) nessun investitore sarà battere il mercato in qualsiasi periodo di tempo. Al contrario, circa la metà di tutti gli investitori, prima di costi di transazione, dovrebbe battere il mercato in ogni periodo. (C) nessun gruppo di investitori sarà battere il mercato nel lungo termine. Dato il numero di investitori nei mercati finanziari, le leggi della probabilità suggerirebbero che un gran numero stanno andando a battere il mercato costantemente per lunghi periodi, non a causa delle loro strategie di investimento, ma perché sono fortunato. Non sarebbe, tuttavia, essere coerente se un numero estremamente elevato di tali investitori utilizzata la stessa strategia di investimento. In un mercato efficiente, i rendimenti attesi da qualsiasi investimento sarà coerente con il rischio di investimento che nel lungo periodo, anche se ci possono essere deviazioni da questi rendimenti attesi a breve termine. Condizioni necessarie per i mercati di efficienza del mercato non diventano automaticamente efficiente. E 'l'azione di investitori, rilevamento occasioni e messa in schemi effetto di battere il mercato, che rendono i mercati efficienti. Le condizioni necessarie per una inefficienza del mercato da eliminare sono le seguenti - (1) L'inefficienza del mercato dovrebbe fornire la base per un piano per battere il mercato e guadagnare rendimenti in eccesso. Per questo per tenere vero - (a) l'attività (o delle attività), che è la fonte di inefficienza deve essere scambiato. (B) Le operazioni costi di esecuzione del sistema devono essere più piccoli dei profitti attesi dal regime. (2) Non ci dovrebbero essere di profitto massimizzazione investitori che (a) riconoscono il potenziale di rendimento addizionale (b) possono replicare il battito del regime di mercato che guadagna il rendimento in eccesso (c) avere le risorse per operare sul titolo fino a quando l'inefficienza scompare efficiente I mercati e gli investitori in cerca di profitto: la contraddizione interna vi è una contraddizione interna in sostenendo che non vi è alcuna possibilità di battere il mercato in un mercato efficiente e quindi richiedono investitori profitto massimizzazione a cercare costantemente modi di battere il mercato e quindi rendendolo efficiente. Se i mercati sono stati, infatti, efficienti, gli investitori dovrebbero smettere di cercare le inefficienze. che porterebbe a mercati di diventare ancora una volta inefficiente. Ha senso pensare a un mercato efficiente come un meccanismo di auto-correzione. dove le inefficienze compaiono a intervalli regolari, ma scompaiono quasi istantaneamente in quanto gli investitori di loro e commercio su a trovare. Proposizioni circa l'efficienza del mercato Proposizione 1: La probabilità di trovare inefficienze in un mercato del risparmio diminuisce con la facilità del trading sugli aumenti di attività. Nella misura in cui gli investitori hanno difficoltà a negoziazione su un titolo, sia perché l'apertura dei mercati non esistono o esistono barriere significative alla negoziazione, le inefficienze nella determinazione dei prezzi possono continuare per lunghi periodi. Esempio: Azioni contro immobiliare NYSE vs NASDAQ Proposizione 2: La probabilità di trovare una inefficienza in un mercato del risparmio aumenta man mano che le transazioni e dei costi di sfruttare le informazioni aumenta inefficienza. Il costo di raccolta di informazioni e di scambio varia ampiamente in tutti i mercati e anche attraverso gli investimenti negli stessi mercati. Come aumentano i costi, si paga sempre meno per cercare di sfruttare queste inefficienze. Offerte pubbliche iniziali. IPO presumibilmente fanno rendimenti superiori, in media. Emergenti azioni dei mercati. Non fanno rendimenti in eccesso investire in azioni perdente. vale a dire titoli che hanno fatto molto male in un certo periodo di tempo prima dovrebbe produce rendimenti in eccesso. costi di transazione sono probabilmente molto più elevato per questi stock since - (a) hanno poi come prodotti a basso prezzo, il conseguente innalzamento delle commissioni di intermediazione e spese (b) il bid-ask diventa una frazione molto più elevato del prezzo totale pagato. (C) trading è spesso sottile su questi stock, e piccoli commerci può causare i prezzi di muoversi. Corollario 1: Gli investitori che possono estabish un vantaggio di costo (sia nella raccolta dei dati o transazioni costi) saranno più in grado di sfruttare le inefficienze di piccole dimensioni rispetto agli altri investitori che non possiedono questo vantaggio. Esempio: Block trades effetto sui prezzi delle azioni specialisti amplificatori sul piano della Borsa Stabilire un vantaggio di costo, soprattutto in relazione alle informazioni, può essere in grado di generare rendimenti superiori, sulla base di questi vantaggi. Così un John Templeton, che ha iniziato a investire nei mercati asiatici e giapponesi Othe ben prima di altri gestori di portafoglio, sarebbe stato in grado di sfruttare i vantaggi informativi che aveva sui suoi coetanei per rendere rendimenti superiori sul suo portafoglio. Proposizione 3: La velocità con cui una inefficienza viene risolto sarà direttamente correlata alla facilità con lo schema di sfruttare la ineffficiency possono essere replicati da altri investitori. La facilità con cui un schema può essere replicato itselft è inversamente proporzionale al tempo, resouces e le informazioni necessarie per eseguirlo. Dal momento che molto pochi gli investitori in possesso di una sola mano le risorse per eliminare un inefficienze attraverso il commercio, è molto più probabile che un inefficienza scompare rapidamente se lo schema utilizzato per sfruttare l'inefficienza è trasparente e può essere copiato da altri investitori. Esempio: investire su frazionamenti azionari rispetto Indice ArbitragePRICE UTILE MULTIPLI Perché è il rapporto del PE usato così ampiamente è una statistica intuitivamente accattivante che mette in relazione il prezzo pagato ai guadagni attuali. è semplice da calcolare per la maggior parte degli stock, ed è ampiamente disponibile, fare confronti tra le scorte semplici. è un proxy per un certo numero di altre caratteristiche dell'impresa inclusi rischio e la crescita. Potenziale per l'uso improprio dei rapporti PE è un modo, per alcuni analisti, per evitare di dover essere espliciti circa le loro ipotesi sui coefficienti di rischio, di crescita e di pagamento. sono molto più propensi a riflettere gli umori del mercato e le percezioni, ma questo può essere visto come una debolezza, soprattutto quando i mercati fanno errori sistematici nella valutazione interi settori. La stima rapporti PE dal Rapporto fondamentali PE per una stabile azienda Una società stabile è una società che cresce ad un ritmo comparabile al tasso di crescita nominale dell'economia in cui opera. Gordon modello di crescita: i dividendi per azione l'anno prossimo r tasso richiesto di rendimento sul tasso di crescita equità gn di dividendi (per sempre) Sostituendo per DPS1 EPS0 (1GN) (Payout ratio) P0 Valore della DPS1 equità previsto, il valore del capitale può essere scritto come: Figura 1: la stima del rapporto del PE per una ditta stabile utilizzando DPS - Deutsche Bank AG Deutsche Bank ha avuto un utile per azione di 46,38 DM nel 1994, e pagato 16,50 DM a titolo di dividendo quell'anno. Il tasso di crescita degli utili e dei dividendi, a lungo termine, è prevista per 6. La beta per Deutsche Bank è 0.92 e il tasso dei titoli a lungo termine in Germania è 7.50. (Il premio utilizzato per azioni tedesche è 4.5.) Dividendo attuale Payout Ratio 16.5046.38 35.58 Tasso di crescita attesa degli utili e dividendi 6 costo del capitale 7,50 0.924.5 11.64 PE Rapporto sulla base dei fondamentali 0.3558 1,06 (0,1164 -.06) 6.69 Detusche Bank vendeva con un rapporto PE 13.50 al momento di questa analisi. (Maggio 1993) Figura 2: Stima il rapporto del PE per una società stabile utilizzando FCFE - Siemens AG Siemens ha avuto un utile per azione di 32,76 DM e pagato dividendi per azione di 13 DM nel 1994. La versione beta per lo stock è 0.93. Il tasso dei titoli a dieci anni in Germania è stato del 7,5 e il premio di rischio per le scorte rispetto ai titoli si presume essere 4,50. La società aveva FCFE nel 1994 di 20 DM per azione FCFE Payout ratio 61.05 Dividend Payout Rapporto 39.68 Tasso di crescita atteso degli utili e dividendi a lungo termine 6 Costo del capitale 7,50 0,93 (4,50) 11.69 PE Rapporto sulla base dei fondamentali 0.6105 1.06 (.1169 - .06) 11.37 Siemens stava vendendo ad un multiplo prezzo-utili di 16,68 nel rapporto di luglio 1993. PE per una ditta di forte crescita il rapporto prezzo-utili per una società ad alta crescita può anche essere correlato ai fondamentali. Nel caso particolare del dividend discount model a due stadi, questo rapporto può essere reso esplicito abbastanza semplice: tasso EPS0 utile per azione nell'anno tasso 0 (anno in corso) g crescita nei primi n anni R richiesti di rendimento del capitale Payout Payout rapporto nei primi n anni gn tasso di crescita dopo n anni per sempre (tasso di crescita stabile) rapporto Payoutn Payout dopo n anni per la ditta stabile determinanti del rapporto del PE per una ditta di forte crescita il lato sinistro dell'equazione è il rapporto prezzo-utili . Essa è determinata per-- Payout ratio durante il periodo di crescita elevata e nel periodo di stabilità: il rapporto PE aumenta con l'aumentare del rapporto di vincita. Rischiosità (attraverso il tasso di sconto R): Il rapporto del PE si riduce con l'aumentare della rischiosità. tasso atteso di crescita degli utili, sia nella fase di forte crescita e stabili: Le PE aumenta con l'aumentare del tasso di crescita, in entrambi i periodi. Figura 3: La stima del rapporto del PE per una ditta di forte crescita nel modello a due stadi supponga che vi è stato chiesto di valutare il rapporto del PE per una ditta che ha le seguenti caratteristiche: Tasso di crescita nei primi cinque anni 25 il rapporto Payout in primi cinque anni 20 tasso di crescita dopo cinque anni 8 Payout ratio dopo cinque anni 50 Beta 1.0 tasso privo di rischio tasso T. Bond tasso 6 di rendimento richiesto 6 1 (5.5) 11.5 Il rapporto stima del PE per questa impresa è 28.75. Figura 4: La stima del rapporto del PE per Nike - 1994 La seguente è una stima del rapporto PE appropriata per Nike nel marzo 1995. Si presume di avere cinque anni di forte crescita sinistra, dopo di che l'azienda dovrebbe essere in stato stazionario . Alta periodo di crescita rendimento atteso del patrimonio netto 18 (Questo è leggermente inferiore al ROE del 1994 di 19,5) atteso Payout Ratio 20 (Questo è il payout corrente) tasso di crescita nel periodo di crescita elevata (1 - Payout Ratio) ROE (1-. 2) (.18) 14.4 Durata del periodo di forte crescita 5 anni la versione beta di Nike attualmente è 1,45, e il tasso sui treasury bond è di 7,5, ottenendo un costo del capitale di: costo del capitale 7.5 1.45 (5.5) 15.48 Stabile periodo di crescita attesi il tasso di crescita 6 La versione beta di Nike in crescita stabile dovrebbe essere 1,10, portando ad un costo del capitale di: costo del capitale 7.5 1.10 (5.5) 13.55 Rendimento atteso on equity 15.00 previsto Payout ratio in fase stabile 1-615 60 Il prezzo - earnings rapporto può essere stimata sulla base di questi ingressi: Nike è stato scambiato a un rapporto prezzo-utili di 14 marzo 0,1995. Si tratta di azioni di classe B, con diritto di voto limitato. Rapporti PE e straordinaria crescita attesi, le ditte anticipato tasso di crescita straordinaria nei primi cinque anni declina 25-8, il rapporto del PE per l'azienda diminuisce anche da 28.75 a 15. Le strategie di investimento che mettono a confronto PE agli attesi tasso di crescita gestori di portafoglio e Gli analisti a volte confrontare rapporti PE per il tasso di crescita atteso per identificare sotto e le scorte sopravvalutate. Nella forma più semplice di questo approccio, le imprese con rapporti PE inferiore al loro tasso di crescita atteso sono visti come sottovalutati. Nella sua forma più generale, il rapporto di rapporto del PE alla crescita viene utilizzato come misura del valore relativo. Problemi con il confronto rapporti PE a crescita prevista Nella sua forma più semplice, non vi è alcuna base per credere che una società è sottovalutata solo perché ha un rapporto PE meno di crescita prevista. Questo rapporto può essere coerente con un abbastanza valore o addirittura una società sopravvalutato, se i tassi di interesse sono alti. o se una società è ad alto rischio. Problemi con il confronto relativo (PEG) Nella sua forma relativa, in cui le imprese sono classificati in base al rapporto di rapporto del PE alla crescita attesa, la classifica fornirà una misura del valore relativo se, la lunghezza del periodo di crescita elevata è la uguale per tutte le imprese tutte le imprese sono di rischio equivalente. Se il modello utilizzato è il CAPM, tutte le imprese hanno gli stessi beta. Il rapporto del PE della ditta sicuro sarà superiore al rapporto PE della società più rischioso a tutti i livelli di crescita, come illustrato in figura 14.4: Il confronto dei rapporti PE I confronti in tutta paesi I confronti sono spesso realizzati tra il rapporto prezzo-utili in vari paesi con l'intenzione di trovare mercati sottovalutati e sopravvalutati. E 'chiaramente fuorviante in questi casi, per confrontare i rapporti di PE in tutta mercato diverso senza il controllo per le differenze nelle variabili sottostanti. Un esempio con i mercati emergenti confronti nel tempo Un altro paragone che viene spesso fatta è tra rapporti PE attraverso il tempo. Mentre i fondamentali (tassi di interesse e crescita prevista) cambiano nel tempo, il rapporto PE cambierà. Un confronto più appropriato non è quindi tra rapporti PE attraverso il tempo, ma tra il rapporto PE effettivo e il rapporto del PE previsto basa fondamentali esistenti in quel momento. C'è una forte relazione positiva tra rapporti di PE e T. Bond tassi. come evidenziato dalla correlazione di 0,67 tra le due variabili. Inoltre, vi è evidenza che la struttura a termine riguarda anche il rapporto del PE. Nel seguente regressione, regrediamo rapporti del PE contro il livello dei tassi di T. Bond e una variabile struttura a termine (T. Bond - tasso T. Bill) EP 3,34 0,7160 T. Bond Tasso - 0,9039 (T. Bond Rate-T. Bill rate) R 2 0.795 parità di altre condizioni, questa regressione suggerisce che ogni 1 aumento del tasso T. Bond aumenta il rapporto EP di 0,716. Ogni 1 aumento della differenza tra i tassi T. Bond e T. Bill riduce il rapporto EP di 0.90. (Come la struttura a termine si appiattisce, rapporti EP dovrebbero aumentare - rapporti PE dovrebbero diminuire) Confrontando i rapporti tra le imprese PE PE rapporti variano tra settori e tra le imprese a causa delle differenze nei fondamentali - la crescita maggiore si traduce generalmente in alti rapporti. Quando i confronti sono fatti tra le imprese, le differenze di rischio, i tassi di crescita e le percentuali di vincita devono essere controllati per esplicitamente. Utilizzando Pro firms - comparabili e Contro L'approccio più comune per stimare il rapporto del PE per una ditta è quello di scegliere un gruppo di aziende comparabili, per calcolare il rapporto medio del PE per questo gruppo e per regolare soggettivamente questa media per le differenze tra la società oggetto di valutazione e le aziende comparabili. Ci sono diversi problemi con questo approccio. La definizione di impresa analoga è essenzialmente personale. L'uso di altre imprese nel settore come il gruppo di controllo non è spesso una soluzione perché le imprese all'interno dello stesso settore possono avere molto diversi mix di business e profili di rischio e di crescita. C'è anche un sacco di potenziale di bias. Anche quando un gruppo legittimo di aziende comparabili può essere costruito, le differenze continueranno a persistere dei fondamentali tra la società oggetto di valutazione e questo gruppo. Utilizzando l'intera sezione trasversale: Un approccio di regressione In contrasto con l'approccio fermo comparabili, le informazioni in tutta la sezione trasversale delle aziende può essere utilizzato per prevedere i PE. Il modo più semplice per riassumere questa informazione è con una regressione multipla. con il rapporto del PE come variabile dipendente, e proxy per il rischio, la crescita e la vincita che formano le variabili indipendenti. Queste regressioni rapporto PE sono stati aggiornati nella sezione seguente utilizzando i dati 1987-1991. La base di dati Compustat è stato utilizzato per estrarre informazioni sul prezzo-utili rapporti, percentuali di vincita e earningsThe di gestione del rischio di cambio di Ian H. Giddy e Gunter Dufey New York University e la University of Michigan 1 (a) Obiettivi del rischio capitolo scambio è l'effetto che impreviste variazioni dei tassi di cambio hanno sul valore dell'impresa. Questo capitolo esplora l'impatto delle fluttuazioni monetarie sui flussi di cassa, delle attività e passività, e sulla reale attività dell'impresa. Tre domande devono essere fatte. In primo luogo, che cosa rischio di cambio fa la faccia ferma, e quali metodi sono disponibili per misurare l'esposizione in valuta In secondo luogo, in base alla natura del l'esposizione e la capacità delle imprese di prevedere valute, quale strategia di gestione del rischio di cambio di copertura o dovrebbe al servizio dell'impresa e, infine, quale dei vari strumenti e tecniche del mercato dei cambi dovrebbe essere impiegato: debito e patrimonio forward e future e opzioni. Il capitolo si conclude suggerendo un quadro che può essere utilizzato per abbinare lo strumento al problema. 1 (b) Qual è lo scambio Rischio di cambio rischio è semplice nel concetto: un potenziale di guadagno o di perdita che si verifica a causa di una variazione dei tassi di cambio. Ad esempio, se un individuo possiede una quota in Hitachi, la società giapponese, lui o lei perderà se il valore dello yen scende. Eppure, da questa semplice domanda molti altri sorgere. In primo luogo, il cui guadagno o la perdita Chiaramente non solo quelli di una controllata, perché possono essere compensati da posizioni assunte altrove in azienda. E non solo gli utili o le perdite delle operazioni in corso, per le aziende il valore è costituito da flussi di cassa futuri attesi, oltre a quelli attualmente in contratto. Ciò che conta, finanza moderna ci dice, è valore per gli azionisti ancora l'impatto di qualsiasi cambio di valuta sul valore per gli azionisti è difficile da valutare, in modo deleghe devono essere utilizzati. La prova accademico che collega le variazioni dei tassi di cambio per i prezzi delle azioni è debole. Inoltre il socio che ha un portafoglio diversificato possono trovare che l'effetto negativo delle variazioni dei tassi di cambio in una impresa è compensato dai guadagni di altre imprese, in altre parole, che il rischio di cambio è diversificabile. Se lo è, che forse il suo un non-rischio. Infine, rischio non è rischio se è previsto. Nella maggior parte delle valute ci sono i futures o contratti di cambio a termine i cui prezzi dare alle imprese una indicazione di dove il mercato si aspetta che le valute di andare. E questi contratti offrono la possibilità di bloccare il cambiamento previsto. Quindi, forse, una migliore concetto di rischio di cambio è impreviste variazioni dei tassi di cambio. Queste e altre questioni giustificano uno sguardo più da vicino questo settore della gestione finanziaria internazionale. 2 imprese devono gestire CAMBIO DI RISCHIO Molte aziende astenersi dalla gestione attiva della loro esposizione in valuta estera, anche se capiscono che le fluttuazioni dei tassi di cambio possono influenzare i loro guadagni e il valore. Fanno questa decisione per una serie di motivi. In primo luogo, la gestione non la comprende. Essi considerano qualsiasi uso di strumenti di gestione del rischio, come ad esempio contratti forward, future e opzioni, come speculativi. O essi sostengono che tali manipolazioni finanziarie si trovano al di fuori del campo delle imprese di competenza. Siamo nel business della produzione di slot machine, e non dovremmo essere il gioco d'azzardo su valute. Forse hanno ragione di temere abusi di tecniche di copertura, ma rifiutando di usare in avanti e gli altri strumenti possono esporre l'azienda a rischi speculativi sostanziali. In secondo luogo, essi sostengono che l'esposizione non può essere misurata. Hanno ragione - l'esposizione valutaria è complessa e può raramente essere misurato con precisione. Ma, come in molte situazioni di business, l'imprecisione non deve essere presa come una scusa per indecisione. In terzo luogo, si dice che l'azienda è oggetto di copertura. Tutte le transazioni, come le importazioni o esportazioni sono coperti, e controllate estere finanziano in valuta locale. Questo ignora il fatto che la maggior parte del valore delle imprese deriva da operazioni non ancora completati, in modo che le operazioni di copertura è una strategia molto incompleta. In quarto luogo, si dice che l'azienda non ha alcun rischio di cambio, perché fa tutto la propria attività in dollari (o di yen, o qualsiasi altra cosa la moneta casa). Ma a momenti di pensiero renderà evidente che, anche se la fattura clienti tedeschi in dollari, quando il marchio gocce vostri prezzi dovranno regolare o youll essere inferiori dai concorrenti locali. Così i ricavi sono influenzati dai cambiamenti di valuta. Infine, essi affermano che il bilancio è coperto su base contabile - soprattutto quando la valuta funzionale è ritenuta il dollaro. I segnali fuorvianti che misura l'esposizione del bilancio può dare sono documentati nelle sezioni successive. Ma c'è qualche giustificazione economica per fare nulla di strategia moderni principi della teoria della finanza suggeriscono, prima facie, che la gestione di esposizione in valuta estera delle imprese può essere né un importante né una preoccupazione legittima. Si è sostenuto, nella tradizione del Teorema di Modigliani-Miller, che l'impresa non può migliorare valore per gli azionisti manipolazioni finanziarie: in particolare, gli investitori si può coprire l'esposizione scambio aziendale eliminando contratti a termine in conformità con la loro partecipazione in una società. I gestori non li servono da ripensamenti quali rischi azionisti vogliono coprire. Un contro-argomento è che i costi di transazione sono in genere maggiori per gli investitori individuali di tutte le imprese. Eppure ci sono ragioni più profonde per cui il rischio di cambio deve essere gestita a livello di impresa. Come verrà illustrato nel materiale che segue, la valutazione dell'esposizione alle fluttuazioni dei tassi di cambio richiede stime dettagliate della predisposizione dei flussi di cassa netti a inaspettate variazioni dei tassi di cambio (Dufey e Srinivasulu, 1983). i manager operativi possono fare tali stime con molta più precisione rispetto azionisti che in genere non hanno la conoscenza dettagliata di concorrenza, i mercati e le tecnologie relative. Inoltre, in tutti, ma i mercati finanziari più perfette, l'azienda ha notevoli vantaggi rispetto agli investitori di ottenere debito relativamente poco costoso in patria e all'estero, prendendo il massimo vantaggio di contributi in conto interessi e riducendo al minimo l'effetto delle tasse e rischio politico. Un'altra linea di ragionamento suggerisce che la gestione del rischio di cambio non importa, perché di determinate condizioni di equilibrio sui mercati internazionali sia per le attività finanziarie e reali. Queste condizioni includono il rapporto tra prezzi dei beni nei diversi mercati, meglio conosciuto come potere d'acquisto (PPP), e tra i tassi di interesse e tassi di cambio, solitamente indicato come l'effetto internazionale Fisher (vedere la sezione successiva). Tuttavia, deviazioni dalla PPP e IFE possono persistere per lunghi periodi di tempo, soprattutto a livello di singola impresa. La variabilità risultante flusso di cassa netto è di importanza in quanto può sottoporre l'azienda ai costi di difficoltà finanziarie. o anche di default. La ricerca moderna in finanza sostiene il ragionamento che i guadagni fluttuazioni che minacciano le aziende hanno continuato ad assorbire vitalità gestione e creditori di tempo, comporta costi out-of-pocket, come le spese legali, e di creare una serie di problemi di funzionamento e di investimento, tra cui scarsi investimenti in RampD. Lo stesso argomento sostiene l'importanza della gestione del rischio di cambio aziendale contro l'affermazione che nei mercati azionari è solo il rischio sistematico che conta. Nella misura in cui il rischio di cambio rappresenta il rischio non sistematico, si può, naturalmente, essere diversificato via - a condizione di nuovo, che gli investitori hanno la stessa qualità di informazioni sulla società, come la gestione - una condizione non rischia di prevalere in pratica. Questo ragionamento è rafforzata dall'effetto probabile che il rischio di cambio ha su imposte pagate dalla società. E 'generalmente accettato che sfruttano protegge l'azienda dalle tasse, perché l'interesse è deducibile dalle tasse mentre i dividendi non sono. Ma la misura in cui una società può aumentare la leva è limitato dal rischio e costi di fallimento. Una società più rischioso, forse uno che non copertura del rischio di cambio, non si può prendere in prestito tanto. Ne consegue che tutto ciò che riduce la probabilità di fallimento permette all'azienda di assumere una maggiore leva finanziaria, e quindi pagare meno tasse per un dato flusso di cassa operativo. Se cambi di copertura riduce le tasse, gli azionisti beneficiano di copertura. Tuttavia, vi è un compito che l'impresa non può eseguire per gli azionisti: nella misura in cui gli individui ad affrontare il rischio di cambio unica a causa dei loro diversi modelli di spesa, essi devono elaborare appropriate strategie di copertura. Gestione aziendale del rischio di cambio in senso tradizionale è in grado di proteggere i rendimenti nominali attesi nella valuta di riferimento (Eaker, 1981) solo. 3 esposizione economica, potere d'acquisto e il tasso INTERNAZIONALE FISHER effetto cambio, tassi di interesse e tassi di inflazione sono collegati tra di loro attraverso una serie classica di relazioni che hanno importazione per la natura del rischio di cambio aziendale. Queste relazioni sono: (1) l'acquisto teoria della parità di potenza, che descrive il legame tra i tassi di inflazione e tassi di cambio relativi (2) l'effetto internazionale di Fisher. che lega le differenze dei tassi di interesse per lo scambio di aspettative sui tassi e (3) la teoria dei tassi forward imparziale. che mette in relazione il tasso di cambio a termine per lo scambio di aspettative di tasso. Queste relazioni, insieme ad altri due legami di parità chiave, sono illustrati nella Figura 1. La parità di potere d'acquisto (PPP) teoria può essere affermato in diversi modi, ma la rappresentazione più comune lega le variazioni dei tassi di cambio a quelli degli indici dei prezzi relativi a due paesi. Tasso di variazione della differenza cambio dei tassi di inflazione Il rapporto è derivato da l'idea di base che, in assenza di restrizioni commerciali variazioni del tasso di cambio variazioni specchio nei livelli dei prezzi relativi nei due paesi. Allo stesso tempo, in condizioni di libero scambio, i prezzi delle materie prime simili non possono differire tra i due paesi, perché arbitraggisti potranno usufruire di tali situazioni fino a differenze di prezzo sono eliminati. Questa legge del prezzo unico porta logicamente l'idea che ciò che è vero di una merce dovrebbe essere vero per l'economia nel suo complesso - il livello dei prezzi nei due paesi dovrebbe essere collegato attraverso il tasso di cambio - e, quindi, l'idea che lo scambio variazioni dei tassi sono legati a differenze di inflazione. L'effetto Fisher internazionale (IFE) afferma che il differenziale dei tassi di interesse sarà esistere solo se il tasso di cambio dovrebbe cambiare in modo tale che il vantaggio del tasso di interesse più elevato è compensato dalla perdita sulle operazioni di cambio. Questo effetto Internazionale Fisher può essere scritto come segue: il tasso atteso di variazione del tasso di cambio Il differenziale di tasso di interesse In termini pratici l'IFE implica che, mentre un investitore in un paese a basso interesse in grado di convertire i suoi fondi nella valuta della alta paese di interesse e pagato un tasso più elevato, il suo guadagno (il differenziale di tasso di interesse) saranno compensati dalla sua perdita attesa a causa delle variazioni dei tassi di cambio. La imparziale Forward Rate teoria afferma che il tasso di cambio a termine è la migliore, e un imparziale, stima del tasso di cambio a pronti futuro atteso. La teoria si fonda nella teoria dei mercati efficienti, ed è ampiamente assunto e ampiamente contestata come una spiegazione precisa. Il tasso atteso è solo una media, ma la teoria dei mercati efficienti ci dice che si tratta di un'aspettativa imparziale - che ci sia una probabilità pari del tasso effettivo di essere al di sopra o al di sotto del valore atteso. La teoria cambio a termine imparziale può affermare semplicemente: Il tasso di cambio atteso Il tasso di cambio a termine Ora possiamo riassumere l'impatto delle variazioni dei tassi di cambio inaspettati sulla società coinvolta a livello internazionale attingendo a queste condizioni di parità. Given sufficient time, competitive forces and arbitrage will neutralize the impact of exchange rate changes on the returns to assets due to the relationship between rates of devaluation and inflation differentials, these factors will also neutralize the impact of the changes on the value of the firm This is simply the principle of Purchasing Power Parity and the Law of One Price operating at the level of the firm. On the liability side, the cost of debt tends to adjust as debt is repriced at the end of the contractual period, reflecting (revised) expected exchange rate changes. And returns on equity will also reflect required rates of return in a competitive market these will be influenced by expected exchange rate changes. Finally the unbiased forward rate theory suggests that locking in the forward exchange rate offers the same expected return as remaining exposed to the ups and downs of the currency -- on average, it can be expected to err as much above as below the forward rate. In the long run, it would seem that a firm operating in this setting will not experience net exchange losses or gains. However, because of contractual, or, more importantly, strategic commitments, these equilibrium conditions rarely hold in the short and medium term. Therefore the essence of foreign exchange exposure, and, significantly, its management, are made relevant by these temporary deviations. 4 IDENTIFYING EXPOSURE . The first step in management of corporate foreign exchange risk is to acknowledge that such risk does exist and that managing it is in the interest of the firm and its shareholders. The next step, however, is much more difficult: the identification of the nature and magnitude of foreign exchange exposure. In other words, identifying what is at risk, and in what way. The focus here is on the exposure of nonfinancial corporations, or rather the value of their assets. This reminder is necessary because most commonly accepted notions of foreign exchange risk hedging deal with assets, i. e. they are pertinent to (simple) financial institutions where the bulk of the assets consists of (paper) assets that have with contractually fixed returns, i. e. fixed income claims, not equities. Clearly, such timece your assets in the currency in which they are denominated applies in general to banks and similar firms. Nonfinancial business firms, on the other hand, have, as a rule, only a relatively small proportion of their total assets in the form of receivables and other financial claims. Their core assets consist of inventories, equipment, special purpose buildings and other tangible assets, often closely related to technological capabilities that give them earnings power and thus value. Unfortunately, real assets (as compared to paper assets) are not labelled with currency signs that make foreign exchange exposure analysis easy. Most importantly, the location of an asset in a country is -- as we shall see -- an all too fallible indicator of their foreign exchange exposure. The task of gauging the impact of exchange rate changes on an enterprise begins with measuring its exposure . that is, the amount, or value, at risk. This issue has been clouded by the fact that financial results for an enterprise tend to be compiled by methods based on the principles of accrual accounting. Unfortunately, this approach yields data that frequently differ from those relevant for business decision-making, namely future cash flows and their associated risk profiles. As a result, considerable efforts are expended -- both by decision makers as well as students of exchange risk -- to reconcile the differences between the point-in-time effects of exchange rate changes on an enterprise in terms of accounting data, referred to as accounting or translation exposure . and the ongoing cash flow effects which are referred to as economic exposure . Both concepts have their grounding in the fundamental concept of transactions exposure . The relationship between the three concepts is illustrated in the Exhibit 2. While exposure concepts have been aptly analyzed elsewhere in this Handbook . some basic concepts are repeated here to make the present chapter self contained. 4 (a) Exposure in a simple transaction. The typical illustration of transaction exposure involves an export or import contract giving rise to a foreign currency receivable or payable. On the surface, when the exchange rate changes, the value of this export or import transaction will be affected in terms of the domestic currency. However, when analyzed carefully, it becomes apparent that the exchange risk results from a financial investment (the foreign currency receivable) or a foreign currency liability (the loan from a supplier) that is purely incidental to the underlying export or import transaction it could have arisen in and of itself through independent foreign borrowing and lending. Thus, what is involved here are simply foreign currency assets and liabilities, whose value is contractually fixed in nominal terms. While this traditional analysis of transactions exposure is correct in a narrow, formal sense, it is really relevant for financial institutions, only. With returns from financial assets and liabilities being fixed in nominal terms, they can be shielded from losses with relative ease through cash payments in advance (with appropriate discounts), through the factoring of receivables, or via the use of forward exchange contracts, unless unexpected exchange rate changes have a systematic effect on credit risk.8 However, the essential assets of nonfinancial firms have noncontractual returns, i. e. revenue and cost streams from the production and sale of their goods and services which can respond to exchange rate changes in very different ways. Consequently, they are characterized by foreign exchange exposure very different from that of firms with contractual returns. MEASURES OF ACCOUNTING EXPOSURE Note: In the case of Income Statements, sales revenues and interest are generally translated at the average historical exchange rate that prevailed during the period depreciation is translated at the appropriate historical exchange rate. Some of the general and administrative expenses as well as cost-of-goods-sold are translated at historical exchange rates, others at current rates. C Assets and liabilities are translated at the current rate, or rate prevailing on the date of the balance sheet. H Assets and liabilities are translated at the historical rate. 4 (b) Accounting exposure. The concept of accounting exposure arises from the need to translate accounts that are denominated in foreign currencies into the home currency of the reporting entity. Most commonly the problem arises when an enterprise has foreign affiliates keeping books in the respective local currency. For purposes of consolidation these accounts must somehow be translated into the reporting currency of the parent company. In doing this, a decision must be made as to the exchange rate that is to be used for the translation of the various accounts. While income statements of foreign affiliates are typically translated at a periodic average rate, balance sheets pose a more serious challenge. To a certain extent this difficulty is revealed by the struggle of the accounting profession to agree on appropriate translation rules and the treatment of the resulting gains and losses. A comparative historical analysis of translation rules may best illustrate the issues at hand. Over time, U. S. companies have followed essentially four types of translation methods, summarized in Exhibit 3. These four methods differ with respect to the presumed impact of exchange rate changes on the value of individual categories of assets and liabilities. Accordingly, each method can be identified by the way in which it separates assets and liabilities into those that are exposed and are, therefore, translated at the current rate, i. e. the rate prevailing on the date of the balance sheet, and those whose value is deemed to remain unchanged, and which are, therefore, translated at the historical rate. The currentnoncurrent method of translation divides assets and liabilities into current and noncurrent categories, using maturity as the distinguishing criterion only the former are presumed to change in value when the local currency appreciates or depreciates vis-agrave-vis the home currency. Supporting this method is the economic rationale that foreign exchange rates are essentially fixed but subject to occasional adjustments that tend to correct themselves in time. This assumption reflected reality to some extent, particularly with respect to industrialized countries during the period of the Bretton Woods system. However, with subsequent changes in the international financial environment, this translation method has become outmoded only in a few countries is it still being used. Under the monetarynonmonetary method all items explicitly defined in terms of monetary units are translated at the current exchange rate, regardless of their maturity. Nonmonetary items in the balance sheet, such as tangible assets, are translated at the historical exchange rate. The underlying assumption here is that the local currency value of such assets increases (decreases) immediately after a devaluation (revaluation) to a degree that compensates fully for the exchange rate change. This is equivalent of what is known in economics as the Law of One Price, with instantaneous adjustment. A similar but more sophisticated translation approach supports the so-called temporal method. Here, the exchange rate used to translate balance sheet items depends on the valuation method used for a particular item in the balance sheet. Thus, if an item is carried on the balance sheet of the affiliate at its current value, it is to be translated using the current exchange rate. Alternatively, items carried at historical cost are to be translated at the historical exchange rate. As a result, this method synchronizes the time dimension of valuation with the method of translation. As long as foreign affiliates compile balance sheets under traditional historical cost principles, the temporal method gives essentially the same results as the monetarynonmonetary method. However, when current value accounting is used, that is, when accounts are adjusted for inflation, then the temporal method calls for the use of the current exchange rate throughout the balance sheet. The temporal method provided the conceptual base for the Financial Accounting Standard Boards Standard 8 (FAS 8), which came into effect in 1976 for all U. S.-based companies and those non-U. S. companies that had to follow U. S. accounting principles in order to raise funds in the public markets of the United States. The temporal method points to a more general issue: the relationship between translation and valuation methods for accounting purposes. When methods of valuation provide results that do not reflect economic reality, translation will fail to remedy that deficiency, but will tend to make the distortion very apparent. To illustrate this point: companies with real estate holdings abroad financed by local currency mortgages found that under FAS 8 their earnings were subject to considerable translation losses and gains. This came about because the value of their assets remained constant, as they were carried on the books at historical cost and translated at historical exchange rates, while the value of their local currency liabilities increased or decreased with every twitch of the exchange rate between reporting dates. In contrast, U. S. companies whose foreign affiliates produced internationally traded goods (minerals or oil, for example) felt very comfortable valuing their assets on a dollar basis. Indeed, this later category of companies were the ones that did not like the transition to the current rate method at all. Here, all assets and liabilities are translated at the exchange rate prevailing on the reporting date. They found the underlying assumption that the value of all assets (denominated in the local currency of the given foreign affiliate) would change in direct proportion to the exchange rate change did not reflect the economic realities of their business. In order to accommodate the conflicting requirements of companies in different situations and still maintain a semblance of conformity and comparability, at the end of 1981 the Financial Accounting Standards Board issued Standard 52, replacing Standard 8. FAS 52 . as it is commonly referred to, uses the currentcurrent method as the basic translation rule. At the same time it mitigates the consequences by allowing companies to move translation losses directly to a special subaccount in the net worth section of the balance sheet, instead of adjusting current income. This latter provision may be viewed as a mere gimmick without much substance, providing at best a signalling function, indicating to users of accounting information that translation gains and losses are of a nature different from items normally found in income statements. A more significant innovation of FAS 52 is the functional currency concept, which gives a company the opportunity to identify the primary economic environment and select the appropriate (functional) currency for each of the corporations foreign entities. This approach reflects the official recognition by the accounting profession that the location of an entity does not necessarily indicate the currency relevant for a particular business. Thus FAS 52 represents an attempt to take into account the fact that exchange rate changes affect different companies in different ways, and that rigid and general rules treating different circumstances in the same manner will provide misleading information. In order to adjust to the diversity of real life FAS 52 had to become quite complex. The following provides a brief road map to the logic of that standard. In applying FAS 52 a company and its accountants must make two decisions in sequence. First, they must determine the functional currency of the entity whose accounts are to be consolidated. For all practical purposes, the choice here is between local currency and the U. S. dollar. In essence, there are a number of specific criteria which provide guidelines for this determination. As usual, extreme cases are relatively easily classified: a foreign affiliate engaged in retailing local goods and services will have the local currency as its functional currency, while a border plant that receives the majority of its inputs from abroad and ships the bulk of the output outside of the host country will have the dollar as its functional currency. If the functional currency is the dollar, foreign currency items on its balance sheet will have to be restated into dollars and any gains and losses are moved through the income statement, just as under FAS 8. If, on the other hand, the functional currency is determined to be the local currency, a second issue arises: whether or not the entity operates in a high inflation environment. High inflation countries are defined as those whose cumulative three-year inflation rate exceeds 100 percent. In that case, essentially the same principles as in FAS 8 are followed. In the case where the cumulative inflation rate falls short of 100 percent, the foreign affiliates books are to be translated using the current exchange rate for all items, and any gains or losses are to go directly as a charge or credit to the equity accounts. FAS 52 has a number of other fairly complex provisions regarding the treatment of hedge contracts, the definition of transactional gains and losses, and the accounting for intercompany transactions. In essence, FAS 52 allows management much more flexibility to present the impact of exchange rate variations in accordance with perceived economic reality by the same token, it provides greater scope for manipulation of reported earnings and it reduces comparability of financial data for different firms. 4 (d) Critique of the Accounting Model of Exposure Even with the increased flexibility of FAS 52, users of accounting information must be aware that there are three system sources of error that can mislead those responsible for exchange risk management (Adler, 1982): 1. Accounting data do not capture all commitments of the firm that give rise to exchange risk. 2. Because of the historical cost principle, accounting values of assets and liabilities do not reflect the respective contribution to total expected net cash flow of the firm. 3. Translation rules do not distinguish between expected and unexpected exchange rate changes. Regarding the first point, it must be recognized that normally, commitments entered into by the firm in terms of foreign exchange, a purchase or a sales contract, for example, will not be booked until the merchandise has been shipped. At best, such obligations are shown as contingent liabilities. More importantly, accounting data reveals very little about the ability of the firm to change costs, prices and markets quickly. Alternatively, the firm may be committed by strategic decisions such as investment in plant and facilities. Such commitments are important criteria in determining the existence and magnitude of exchange risk. The second point surfaced in our discussion of the temporal method: whenever asset values differ from market values, translation--however sophisticated--will not redress this original shortcoming. Thus, many of the perceived problems of FAS 8 had their roots not so much in translation, but in the fact that in an environment of inflation and exchange rate changes, the lack of current value accounting frustrates the best translation efforts. Finally, translation rules do not take account of the fact that exchange rate changes have two components: (1) expected changes that are already reflected in the prices of assets and the costs of liabilities (relative interest rates) and (2) the real goods and services . the basic rationale for corporate foreign exchange exposure management is to shield net cash flows, and thus the value of the enterprise, from unanticipated exchange rate changes. This thumbnail sketch of the economic foreign exchange exposure concept has a number of significant implications, some of which seem to be at variance with frequently used ideas in the popular literature and apparent practices in business firms. Specifically, there are implications regarding (1) the question of whether exchange risk originates from monetary or nonmonetary transactions, (2) a reevaluation of traditional perspectives such as transactions risk, and (3) the role of forecasting exchange rates in the context of corporate foreign exchange risk management. 4 (f) Contractual versus Noncontractual Returns An assessment of the nature of the firms assets and liabilities and their respective cash flows shows that some are contractual, i. e. fixed in nominal, monetary terms. Such returns, earnings from fixed interest securities and receivables, for example, and the negative returns on various liabilities are relatively easy to analyze with respect to exchange rate changes: when they are denominated in terms of foreign currency, their terminal value changes directly in proportion to the exchange rate change. Thus, with respect to financial items, the firm is concerned only about net assets or liabilities denominated in foreign currency, to the extent that maturities (actually, durations of asset classes) are matched. What is much more difficult, however, is to gauge the impact of an exchange rate change on assets with noncontractual returns. While conventional discussions of exchange risk focus almost exclusively on financial assets, for trading and manufacturing firms at least, such assets are relatively less important than others. Indeed, equipment, real estate, buildings and inventories make the decisive contribution to the total cash flow of those firms. (Indeed companies frequently sell financial assets to banks, factors, or captive finance companies in order to leave banking to bankers and instead focus on the management of core assets) And returns on such assets are affected in quite complex ways by changes in exchange rates. The most essential consideration is how the prices and costs of the firm will react in response to an unexpected exchange rate change. For example, if prices and costs react immediately and fully to offset exchange rate changes, the firms cash flows are not exposed to exchange risk since they will not be affected in terms of the base currency. Example of the Effect of Devaluation on Inventory Assume the French subsidiary of a U. S. corp. has an inventory destined for sale to Germany. Exchange rates are as follows: before devaluation 1 FF .15 .30 DM after devaluation 1 FF .12 .20 DM WHAT DOES THE EFFECT OF EXCHANGE RATE CHANGES ON OPERATIONAL CASH FLOWS DEPEND ON 1. VOLUME EFFECTS (compensate for changes in profit margins) 2. PRICING FLEXIBILITY (change in margins to offset effect of exchange rate change) 3. DIVERSIFICATION of markets for inputs and outputs 4. PRODUCTION AND SALES FLEXIBILITY (ability to shift markets and sources quickly) Inventories may serve as a good illustration of this proposition. The value of an inventory in a foreign subsidiary is determined not only by changes in the exchange rate, but also by a subsequent price change of the product--to the extent that the underlying cause of this price change is the exchange rate change. Thus, the dollar value of an inventory destined for export may increase when the currency of the destination country appreciates, provided its local currency prices do not decrease by the full percentage of the appreciation. Exhibit 4 provides a numerical illustration. The effect on the local currency price depends, in part, on competition in the market. The behavior of foreign and local competitors, in turn, depends on capacity utilization, market share objectives, likelihood of cost adjustments and a host of other factors. Of course, firms are not only interested in the value change or the behavior of cash flows of a single asset, but rather in the behavior of all cash flows. Again, price and cost adjustments need to be analyzed. For example, a firm that requires raw materials from abroad for production will usually find its stream of cash outlays going up when its local currency depreciates against foreign currencies. Yet the depreciation may cause foreign suppliers to lower prices in terms of foreign currencies for the purpose of maintaining market share. WHAT IS ECONOMIC EXPOSURE PDVSA, the Venezuelan state-owned oil company, recently set up an oil refinery near Rotterdam, The Netherlands for shipment to Germany and other continental European countries. The firm planned to invoice its clients in ECU, the official currency unit of the European Community. The treasurer is considering sources of long term financing. In the past all long term finance has been provided by the parent company, but working capital required to pay local salaries and expenses has been financed in Dutch guilders. The treasurer is not sure whether the short term debt should be hedged, or what currency to issue long term debt in. This is an example of a situation where the definition of exposure has a direct impact on the firms hedging decisions. Translation exposure has to do with the location of the assets . which in this case would be a totally misleading measure of the effect of exchange rate changes on the value of the unit. After all, the oil comes from Venezuela and is shipped to Germany: its temporary resting place, be it a refinery in Rotterdam or a tanker en route to Germany, has no import. Both provide value added, but neither determine the currency of revenues. So financing should definitely not be done in Dutch guilders. Transactions exposure has to do with the currency of denomination of assets like accounts receivable or payable. Once sales to Germany have been made and invoicing in ECU has taken place, PDVSA-Netherlands has contractual, ECU-denominated assets that should be financed or hedged with ECU. For future sales, however, PDVSA-Netherlands does not have exposure to the ECU. This is because the currency of determination is the U. S. dollar. Economic exposure is tied to the currency of determination of revenues and costs. Since the world market price of oil is dollars, this is the effective currency in which PDVSAs future sales to Germany are made. If the ECU rises against the dollar, PDVSA must adjust its ECU price down to match those of competitors like Aramco. If the dollar rises against the ECU, PDVSA can and should raise prices to keep the dollar price the same, since competitors would do likewise. Clearly the currency of determination is influenced by the currency in which competitors denominate prices. 4 (g) Currency of denomination versus currency of determination One of the central concepts of modern international corporate finance is the distinction between the currency in which cash flows are denominated and the currency that determines the size of the cash flows. In the example in the previous section, it does not matter whether, as a matter of business practice, the firm may contract, be invoiced in, and pay for each individual shipment in its own local currency. If foreign exporters do not provide price concessions, the cash outflow of the importer behaves just like a foreign currency cash flow even though payments are made in local currency, they occur in greater amounts. As a result, the cash flow, even while denominated in local currency, is determined by the relative value of the foreign currency. The functional currency concept introduced in FAS 52 is similar to the currency of determination -- but not exactly. The currency of determination refers to revenue and operating expense flows, respectively the functional currency concept pertains to an entity as a whole, and is, therefore, less precise. To complicate things further, the currency of recording . that is, the currency in which the accounting records are kept, is yet another matter. For example, any debt contracted by the firm in foreign currency will always be recorded in the currency of the country where the corporate entity is located . However, the value of its legal obligation is established in the currency in which the contract is denominated. An example of the importance of these distinctions may be found in Exhibit 5. It is possible, therefore, that a firm selling in export markets may record assets and liabilities in its local currency and invoice periodic shipments in a foreign currency and yet, if prices in the market are dominated by transactions in a third country, the cash flows received may behave as if they were in that third currency. To illustrate: a Brazilian firm selling coffee to West Germany may keep its records in cruzeiros, invoice in German marks, and have DM-denominated receivables, and physically collect DM cash flow, only to find that its revenue stream behaves as if it were in U. S. dollars This occurs because DM-prices for each consecutive shipment are adjusted to reflect world market prices which, in turn, tend to be determined in U. S. dollars. The significance of this distinction is that the currency of denomination is (relatively) readily subject to management discretion, through the choice of invoicing currency. Prices and cash flows, however, are determined by competitive conditions which are beyond the immediate control of the firm. Yet an additional dimension of exchange risk involves the element of time . In the very short run, virtually all local currency prices for real goods and services (although not necessarily for financial assets) remain unchanged after an unexpected exchange rate change. However, over a longer period of time, prices and costs move inversely to spot rate changes the tendency is for Purchasing Power Parity and the Law of One Price to hold. In reality, this price adjustment process takes place over a great variety of time patterns. These patterns depend not only on the products involved, but also on market structure, the nature of competition, general business conditions, government policies such as price controls, and a number of other factors. Considerable work has been done on the phenomenon of pass-through of price changes caused by (unexpected) exchange rate changes. And yet, because all the factors that determine the extent and speed of pass-through are very firm-specific and can be analyzed only on a case-by-case basis at the level of the operating entity of the firm (or strategic business unit), generalizations remain difficult to make. Exhibit 6 summarizes the firm-specific effects of exchange rate changes on operating cash flows. Conceptually, though, it is important to determine the time frame within which the firm cannot react to (unexpected) rate changes by (1) raising prices (2) changing markets for inputs and outputs andor (3) adjusting production and sales volumes. Sometimes, at least one of these reactions is possible within a relatively short time at other times the firm is locked-in through contractual or strategic commitments extending considerably into the future. Indeed, those firms which are free to react instantaneously and fully to adverse (unexpected) rate changes are not subject to exchange risk. A further implication of the time-frame element is that exchange risk stems from the firms position when its cash flows are, for a significant period, exposed to (unexpected) exchange rate changes, rather than the risk resulting from any specific international involvement. Thus, companies engaged purely in domestic transactions but who have dominant foreign competitors may feel the effect of exchange rate changes in their cash flows as much or even more than some firms that are actively engaged in exports, imports, or foreign direct investment. 6 MANAGING ECONOMIC EXPOSURE 6 (a) Economic Effects of Unanticipated Exchange Rate Changes on Cash Flows . From this analytical framework, some practical implications emerge for the assessment of economic exposure. First of all, the firm must project its cost and revenue streams over a planning horizon that represents the period of time during which the firm is locked-in, or constrained from reacting to (unexpected) exchange rate changes. It must then assess the impact of a deviation of the actual exchange rate from the rate used in the projection of costs and revenues. STEPS IN MANAGING ECONOMIC EXPOSURE 1. Estimation of planning horizon as determined by reaction period. 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 between direct or indirect debt denomination. 9. Decision on trade-off between arbitrage gains vs. exchange risk stemming from exposure in markets where rates are distorted by controls. 10. Decision about residual risk: consider adjusting business strategy. Subsequently, the effects on the various cash flows of the firm must be netted over product lines and markets to account for diversification effects where gains and losses could cancel out, wholly or in part. The remaining net loss or gain is the subject of economic exposure management. For a multiunit, multiproduct, multinational corporation the net exposure may not be very large at all because of the many offsetting effects.7 By contrast, enterprises that have invested in the development of one or two major foreign markets are typically subject to considerable fluctuations of their net cash flows, regardless of whether they invoice in their own or in the foreign currency. For practical purposes, three questions capture the extent of a companys foreign exchange exposure. 1. How quickly can the firm adjust prices to offset the impact of an unexpected exchange rate change on profit margins 2. How quickly can the firm change sources for inputs and markets for outputs Or, alternatively, how diversified are a companys factor and product markets 3. To what extent do volume changes, associated with unexpected exchange rate changes, have an impact on the value of assets Normally, the executives within business firms who can supply the best estimates on these issues tend to be those directly involved with purchasing, marketing, and production. Finance managers who focus exclusively on credit and foreign exchange markets may easily miss the essence of corporate foreign exchange risk. 6 (b) Financial versus operating strategies for hedging. When operating (cash) inflows and (contractual) outflows from liabilities are affected by exchange rate changes, the general principle of prudent exchange risk management is: any effect on cash inflows and outflows should cancel out as much as possible. This can be achieved by maneuvering assets, liabilities or both. When should operations -- the asset side -- be used We have demonstrated that exchange rate changes can have tremendous effects on operating cash flows. Does it not therefore make sense to adjust operations to hedge against these effects Many companies, such as Japanese auto producers, are now seeking flexibility in production location, in part to be able to respond to large and persistent exchange rate changes that make production much cheaper in one location than another. Among the operating policies are the shifting of markets for output, sources of supply, product-lines, and production facilities as a defensive reaction to adverse exchange rate changes. Put differently, deviations from purchasing power parity provide profit opportunities for the operations-flexible firm. This philosophy is epitomized in the following quotation. It has often been joked at Philips that in order to take advantage of currency movements, it would be a good idea to put our factories aboard a supertanker, which could put down anchor wherever exchange rates enable the company to function most efficiently. In the present currency markets. this would certainly not be a suitable means of transport for taking advantage of exchange rate movements. An aeroplane would be more in line with the requirements of the present era. The problem is that Philips production could not fit into either craft. It is obvious that such measures will be very costly, especially if undertaken over a short span of time. it follows that operating policies are not the tools of choice for exchange risk management. Hence operating policies which have been designed to reduce or eliminate exposure will only be undertaken as a last resort, when less expensive options have been exhausted. It is not surprising, therefore, that exposure management focuses not on the asset side, but primarily on the liability side of the firms balance sheet. Exhibit 7 provides a summary of the steps involved in managing economic exposure. Whether and how these steps should be implemented depends first, on the extent to which the firm wishes to rely on currency forecasting to make hedging decisions, and second, on the range of hedging tools available and their suitability to the task. These issues are addressed in the next two sections. 5 GUIDELINES FOR CORPORATE FORECASTING OF EXCHANGE RATES Academics and practitioners have sought the determinants of exchange rate changes ever since there were currencies. Many students have learned about the balance of trade and how the more a country exports, the more demand there is for its currency, and so the stronger is its exchange rate. In practice, the story is a lot more complex. Research in the foreign exchange markets have come a long way since the days when international trade was thought to be the dominant factor determining the level of the exchange rate. Monetary variables, capital flows, rational expectations and portfolio balance are all now understood to factor into the determination of currencies in a floating exchange rate system. Many models have been developed to explain and to forecast exchange rates. No model has yet proved to be the definitive one, perhaps because the structure of the worlds economies and financial markets are undergoing such rapid evolution. Corporations nevertheless avidly seek ways to predict currencies, in order to decide when and when not to hedge. The models they use are typically one or more of the following kinds: political event analysis . or fundamental . or technical . Academic students of international finance, in contrast, find strong empirical support for the role of arbitrage in global financial markets, and for the view that exchange rates exhibit behavior that is characteristic of other speculative asset markets. Exchange rates react quickly to news. Rates are far more volatile than changes in underlying economic variables they are moved by changing expectations, and hence are difficult to forecast. In a broad sense they are efficient, but tests of efficiency face inherent obstacles in testing the precise nature of this efficiency directly. The central efficient market model is the unbiased forward rate theory introduced earlier. It says that the forward rate equals the expected future level of the spot rate. Because the forward rate is a contractual price, it offers opportunities for speculative profits for those who correctly assess the future spot price relative to the current forward rate. Specifically, risk neutral players will seek to make a profit their forecast differs from the forward rate, so if there are enough such participants the forward rate will always be bid up or down until it equals the expected future spot. Because expectations of future spot rates are formed on the basis of presently available information (historical data) and an interpretation of its implication for the future, they tend to be subject to frequent and rapid revision. The actual future spot rate may therefore deviate markedly from the expectation embodied in the present forward rate for that maturity. The actual exchange rate may deviate from the expected by some random error. As is indicated in Exhibit 8, in an efficient market the forecasting error will be distributed randomly, according to some probability distribution, with a mean equal to zero. An implication of this is that todays forecast, as represented by the forward rate, is equal to yesterdays forward plus some random amount. In other words, the forward rate itself follows a random walk. Another way of looking at these errors to consider them as speculative profits or losses: what you would gain or lose of you consistently bet against the forward rate. Can they be consistently positive or negative A priori reasoning suggests that this should not be the case. Otherwise one would have to explain why consistent losers do not quit the market, or why consistent winners are not imitated by others or do not increase their volume of activity, thus causing adjustment of the forward rate in the direction of their expectation. Barring such explanation, one would expect that the forecast error is sometimes positive, sometimes negative, alternating in a random fashion, driven by unexpected events in the economic and political environment. Rigorously tested academic models have cast doubt on the pure unbiased forward rate theory of efficiency, and demonstrated the presence of speculative profit opportunities (for example, by the use of filter rules). However it is also logical to suppose that speculators will bear foreign exchange risk only if they are compensated with a risk premium. Are the above-zero expected returns excessive in a risk-adjusted sense Given the small size of the bias in the forward exchange market, and the magnitude of daily currency fluctuations, the answer is probably not. As a result of their finding that the foreign exchange markets are among the worlds most efficient, academics argue the exchange rate forecasting by corporations, in the sense of trying to beat the market, plays a role only under very special circumstances. Indeed few firms are actively decide to commit real assets in order to take currency positions. Rather, they get involved with foreign currencies in the course of pursuing profits from the exploitation of a competitive advantage rather than being based on currency expectations, this advantage is based on expertise in such areas as production, marketing, the organization of people, or other technical resources. If someone does have special expertise in forecasting foreign exchange rates, such skills can usually be put to use without incurring the risks and costs of committing funds to other than purely financial assets. Most finance managers of nonfinancial enterprises concentrate on producing and selling goods they should find themselves acting as speculative foreign exchange traders only because of an occasional opportunity encountered in the course of their normal operations. Only when foreign exchange markets are systematically distorted by government controls on financial institutions do the operations of trading and manufacturing firms provide an opportunity to move funds and gain from purely financial transactions. Exhibit 9 offers a flowchart of criteria for forecasting and hedging decisions. Forecasting exchange rate changes, however, is important for planning purposes. To the extent that all significant managerial tasks are concerned with the future, anticipated exchange rate changes are a major input into virtually all decisions of enterprises involved in and affected by international transactions. However, the task of forecasting foreign exchange rates for planning and decision-making purposes, with the purpose of determining the most likely exchange rate, is quite different from attempting to beat the market in order to derive speculative profits. Expected exchange rate changes are revealed by market prices when rates are free to reach their competitive levels. Organized futures or forward markets provide inexpensive information regarding future exchange rates, using the best available data and judgment. Thus, whenever profit-seeking, well-informed traders can take positions, forward rates, prices of future contracts, and interest differentials for instruments of similar riskiness (but denominated in different currencies), provide good indicators of expected exchange rates. In this fashion, an input for corporate planning and decision-making is readily available in all currencies where there are no effective exchange controls. The advantage of such market-based rates over in-house forecasts is that they are both less expensive and more likely to be accurate. Market rates are determined by those who tend to have the best information and track-record incompetent market participants lose money and are eliminated. The nature of this market-based expected exchange rate should not lead to confusing notions about the accuracy of prediction. In speculative markets, all decisions are made on the basis of interpretation of past data however, new information surfaces constantly. Therefore, market-based forecasts rarely will come true. The actual price of a currency will either be below or above the rate expected by the market. If the market knew which would be more likely, any predictive bias quickly would be corrected. Any predictable, economically meaningful bias would be corrected by the transactions of profit-seeking transactors. Example: Hedging with a Forward Contract Janet Fredericks, Foreign Exchange Manager at Murray Chemical, was informed that Murray was selling 25,000 tonnes of naphtha to Canada for a total price of C11,500,000, to be paid upon delivery in two months time. To protect her company, she arranged to sell 11.5 million Canadian dollars forward to the Royal Bank of Montreal. The two month forward contract price was US0.8785 per Canadian dollar. Two months and two days later, Fredericks received US10,102,750 from RBM and paid RBM C11,500,000, the amount received from Murrays customer. The importance of market-based forecasts for a determination of the foreign exchange exposure of the firm is that of a benchmark against which the economic consequences of deviations must be measured. This can be put in the form of a concrete question: How will the expected net cash flow of the firm behave if the future spot exchange rate is not equal to the rate predicted by the market when commitments are made The nature of this kind of forecast is completely different from trying to outguess the foreign exchange markets 7 TOOLS AND TECHNIQUES FOR THE MANAGEMENT OF FOREIGN EXCHANGE RISK In this section we consider the relative merits of several different tools for hedging exchange risk, including forwards, futures, debt, swaps and options. We will use the following criteria for contrasting the tools. First, there are different tools that serve effectively the same purpose. Most currency management instruments enable the firm to take a long or a short position to hedge an opposite short or long position. Thus one can hedge a DM payment using a forward exchange contract, or debt in DM, or futures or perhaps a currency swap. In equilibrium the cost of all will be the same, according to the fundamental relationships of the international money market as illustrated in Exhibit 1. They differ in details like default risk or transactions costs, or if there is some fundamental market imperfection. indeed in an efficient market one would expect the anticipated cost of hedging to be zero. This follows from the unbiased forward rate theory. Second, tools differ in that they hedge different risks. In particular, symmetric hedging tools like futures cannot easily hedge contingent cash flows: options may be better suited to the latter. 7 (a) Tools and techniques: foreign exchange forwards Foreign exchange is, of course, the exchange of one currency for another. Trading or dealing in each pair of currencies consists of two parts, the spot market . where payment (delivery) is made right away (in practice this means usually the second business day), and the forward market . The rate in the forward market is a price for foreign currency set at the time the transaction is agreed to but with the actual exchange, or delivery, taking place at a specified time in the future. While the amount of the transaction, the value date, the payments procedure, and the exchange rate are all determined in advance, no exchange of money takes place until the actual settlement date . This commitment to exchange currencies at a previously agreed exchange rate is usually referred to as a forward contract . Forward contracts are the most common means of hedging transactions in foreign currencies, as the example in Exhibit 10 illustrates. The trouble with forward contracts, however, is that they require future performance, and sometimes one party is unable to perform on the contract. When that happens, the hedge disappears, sometimes at great cost to the hedger. This default risk also means that many companies do not have access to the forward market in sufficient quantity to fully hedge their exchange exposure. For such situations, futures may be more suitable. 7 (b) Currency futures Outside of the interbank forward market, the best-developed market for hedging exchange rate risk is the currency futures market. In principle, currency futures are similar to foreign exchange forwards in that they are contracts for delivery of a certain amount of a foreign currency at some future date and at a known price. In practice, they differ from forward contracts in important ways. One difference between forwards and futures is standardization. Forwards are for any amount, as long as its big enough to be worth the dealers time, while futures are for standard amounts, each contract being far smaller that the average forward transaction. Futures are also standardized in terms of delivery date. The normal currency futures delivery dates are March, June, September and December, while forwards are private agreements that can specify any delivery date that the parties choose. Both of these features allow the futures contract to be tradable. Another difference is that forwards are traded by phone and telex and are completely independent of location or time. Futures, on the other hand, are traded in organized exchanges such the LIFFE in London, SIMEX in Singapore and the IMM in Chicago. But the most important feature of the futures contract is not its standardization or trading organization but in the time pattern of the cash flows between parties to the transaction. In a forward contract, whether it involves full delivery of the two currencies or just compensation of the net value, the transfer of funds takes place once: at maturity. With futures, cash changes hands every day during the life of the contract, or at least every day that has seen a change in the price of the contract. This daily cash compensation feature largely eliminates default risk. Thus forwards and futures serve similar purposes, and tend to have identical rates, but differ in their applicability. Most big companies use forwards futures tend to be used whenever credit risk may be a problem. 7 (c) Debt instead of forwards or futures Debt -- borrowing in the currency to which the firm is exposed or investing in interest-bearing assets to offset a foreign currency payment -- is a widely used hedging tool that serves much the same purpose as forward contracts. Consider an example. In Exhibit 10, Fredericks sold Canadian dollars forwards. Alternatively she could have used the Eurocurrency market to achieve the same objective. She would borrow Canadian dollars, which she would then change into francs in the spot market, and hold them in a US dollar deposit for two months. When payment in Canadian dollars was received from the customer, she would use the proceeds to pay down the Canadian dollar debt. Such a transaction is termed a money market hedge . The cost of this money market hedge is the difference between the Canadian dollar interest rate paid and the US dollar interest rate earned. According to the interest rate parity theorem . the interest differential equals the forward exchange premium, the percentage by which the forward rate differs from the spot exchange rate. So the cost of the money market hedge should be the same as the forward or futures market hedge, unless the firm has some advantage in one market or the other. The money market hedge suits many companies because they have to borrow anyway, so it simply is a matter of denominating the companys debt in the currency to which it is exposed. that is logical. but if a money market hedge is to be done for its own sake, as in the example just given, the firm ends up borrowing from one bank and lending to another, thus losing on the spread. This is costly, so the forward hedge would probably be more advantageous except where the firm had to borrow for ongoing purposes anyway. 7 (d) Currency options Many companies, banks and governments have extensive experience in the use of forward exchange contracts. With a forward contract one can lock in an exchange rate for the future. There are a number of circumstances, however, where it may be desirable to have more flexibility than a forward provides. For example a computer manufacturer in California may have sales priced in U. S. dollars as well as in German marks in Europe. Depending on the relative strength of the two currencies, revenues may be realized in either German marks or dollars. In such a situation the use of forward or futures would be inappropriate: theres no point in hedging something you might not have. What is called for is a foreign exchange option: the right, but not the obligation, to exchange currency at a predetermined rate. A foreign exchange option is a contract for future delivery of a currency in exchange for another, where the holder of the option has the right to buy (or sell) the currency at an agreed price, the strike or exercise price, but is not required to do so. The right to buy is a call the right to sell, a put . For such a right he pays a price called the option premium . The option seller receives the premium and is obliged to make (or take) delivery at the agreed-upon price if the buyer exercises his option. In some options, the instrument being delivered is the currency itself in others, a futures contract on the currency. American options permit the holder to exercise at any time before the expiration date European options, only on the expiration date. Steve Yamamoto of Frito-Lay had just agreed to purchase I5 million worth of potatoes from his supplier in County Cork, Ireland. Payment of the five million punt was to be made in 245 days time. The dollar had recently plummeted against all the EMS currencies and Yamamoto wanted to avoid any further rise in the cost of imports. He viewed the dollar as being extremely instable in the current environment of economic tensions. Having decided to hedge the payment, he had obtained dollarpunt quotes of 2.25 spot, 2.19 for 245 days forward delivery. His view, however, was that the dollar was bound to rise in the next few months, so he was strongly considering purchasing a call option instead of buying the punt forward. At a strike price of 2.21, the best quote he had been able to obtain was from the Ballad Bank of Dublin, who would charge a premium of 0.85 of the principal. Yamamoto decided to buy the call option. In effect, he reasoned, Im paying for downside protection while not limiting the possible savings I could reap if the dollar does recover to a more realistic level. In a highly volatile market where crazy currency values can be reached, options make more sense than taking your chances in the market, and youre not locked into a rock-bottom forward rate. This simple example illustrates the lopsided character of options. Futures and forwards are contracts in which two parties oblige themselves to exchange something in the future. They are thus useful to hedge or convert known currency or interest rate exposures. An option, in contrast, gives one party the right but not the obligation to buy or sell an asset under specified conditions while the other party assumes an obligation to sell or buy that asset if that option is exercised. Figure 1 illustrates the two possible outcomes of an option such as that bought by Steve Yamamoto. When should a company like Frito-Lay use options in preference to forwards or futures In the example, Yamamoto had a view on the currencys direction that differed from the forward rate. Taken alone, this would suggest taking a position. But he also had a view on the dollars volatility . Options provide the only convenient means of hedging or positioning volatility risk. Indeed the price of an option is directly influenced by the outlook for a currencys volatility: the more volatile, the higher the price. To Yamamoto, the price is worth paying. In other words he thinks the true volatility is greater than that reflected in the options price. This example highlights one set of circumstances under which a company should consider the use of options. A currency call or put options value is affected by both direction and volatility changes, and the price of such an option will be higher, the more the markets expectations (as reflected in the forward rate) favor exercise and the greater the anticipated volatility. For example, during the crisis in the European Monetary System of mid-1993, put options on the French franc became very expensive for two reasons. First, high French interest rates designed to support the franc drove the forward rate to a discount against the German mark. Second, anticipated volatility of the DMFF exchange rate jumped as dealers speculated on a possible break-up of the EMS. With movements much greater than the EMS official bands possible, the expected gain from exercising puts became much greater. It was an appropriate time for companies with French exposure to buy puts, but the cost would exceed the expected gain unless the corporate Treasury anticipated a greater change, or an even higher volatility, than those reflected in the market price of options. Finally, one can justify the limited use of options by reference to the deleterious effect of financial distress alluded to in section 2. Unmanaged exchange rate risk can cause significant fluctuations in the earnings and the market value of an international firm. A very large exchange rate movement may cause special problems for a particular company, perhaps because it brings a competitive threat from a different country. At some level, the currency change may threaten the firms viability, bringing the costs of bankruptcy to bear. To avert this, it may be worth buying some low-cost options that would pay off only under unusual circumstances, ones that would particularly hurt the firm. Out-of-the-money options may be a useful and cost-effective way to hedge against currency risks that have very low probabilities but which, if they occur, have disproportionately high costs to the company. 8 CONTROLLING CORPORATE TREASURY TRADING RISKS In a corporation, there is no such thing as being perfectly hedged. Not every transaction can be matched, for international trade and production is a complex and uncertain business. As we have seen, even identifying the correct currency of exposure, the currency of determination, is tricky. Flexibility is called for, and management must necessarily give some discretion, perhaps even a lot of discretion, to the corporate treasury department or whichever unit is charged with managing foreign exchange risks. Some companies, feeling that foreign exchange is best handled by professionals, hire ex-bank dealers other groom engineers or accountants. Yet however talented and honorable are these individuals, it has become evident that some limits must be imposed on the trading activities of the corporate treasury, for losses can get out of hand even in the best of companies. In 1992 a Wall Street Journal reporter found that Dell Computer Corporation, a star of the retail PC industry, had been trading currency options with a face value that exceeded Dells annual international sales, and that currency losses may have been covered up. Complex options trading was in part responsible for losses at the treasury of Allied-Lyons, the British foods group. The 150 million lost almost brought the company to its knees, and the publicity precipitated a management shake-out. In 1993 the oil giant Royal Dutch-Shell revealed that currency trading losses of as much as a billion dollars had been uncovered in its Japanese subsidiary. Clearly, performance measurement standards, accountability and limits of some form must be part of a treasury foreign currency hedging program. Space does not permit a detailed examination of trading control methods, but some broad principles can be stated. First, management must elucidate the goals of exchange risk management, preferably in operational terms rather than in platitudes such as we hedge all foreign exchange risks. Second, the risks of in-house trading (for thats often what it is) must be recognized. These include losses on open positions from exchange rate changes, counterparty credit risks, and operations risks. Third, for all net positions taken, the firm must have an independent method of valuing, marking-to-market, the instruments traded. This marking to market need not be included in external reports, if the positions offset other exposures that are not marked to market, but is necessary to avert hiding of losses. Wherever possible, marking to market should be based on external, objective prices traded in the market. Fourth, position limits should be made explicit rather than treated as a problem we would rather not discuss. Instead of hamstringing treasury with a complex set of rules, limits can take the form of prohibiting positions that could incur a loss (or gain) beyond a certain amount, based on sensitivity analysis. As in all these things, any attempt to cover up losses should reap severe penalties. Finally, counterparty risks resulting from over-the-counter forward or swap contracts should be evaluated in precisely the same manner as is done when the firm extends credit to, say, suppliers or customers. In all this, the chief financial officer might well seek the assistance of an accounting or consulting firm, and may wish to purchase software tailored to the purposes. This chapter offers the reader an introduction to the complex subject of the measurement and management of foreign exchange risk. We began by noting some problems with interpretation of the concept, and entered the debate as to whether and why companies should devote active managerial resources to something that is so difficult to define and measure. Accountants efforts to put an objective value on a firm involved in international business has led many to focus on the translated balance sheet as a target for hedging exposure. As was demonstrated, however, there are numerous realistic situations where the economic effects of exchange rate changes differ from those predicted by the various measures of translation exposure. In particular, we emphasized the distinctions between the currency of location, the currency of denomination, and the currency of determination of a business. After giving some guidelines for the management of economic exposure, the chapter addressed the thorny question of how to approach currency forecasting. We suggested a market-based approach to international financial planning, and cast doubt on the ability of the corporations treasury department to outperform the forward exchange rate. The chapter then turned to the tools and techniques of hedging, contrasting the applications that require forwards, futures, money market hedging, and currency options. In Exhibit 11, we present a sketch of how a company may approach the exchange risk management task, based on the principles laid out in this chapter. Sorry, not all exhibits appear in this version. Alder, Michael. Translation Methods and Operational Foreign Exchange Risk Management, Chapter 6 of Goumlran Bergendahl, (ed.) International Financial Management, Stockholm: Norstedts, 1982. Aliber, Robert Z. Exchange Risk and Corporate International Finance. New York: John Wiley and Sons, 1979. Cornell, Bradford. Inflation, Relative Price Changes, and Exchange Risk, Financial Management, Autumn 1980, pp. 30-44. Dufey, Gunter. Corporate Finance and Exchange Rate Variations, Financial Management, Summer 1972, pp. 51-57. Dufey, Gunter, and Ian Giddy. International Financial Planning: The Use of Market-Based Forecasts, California Management Review, Fall 1978, pp. 69-81. Dukes, R. An Empirical Investigation of the Effects of Statement of Financial Accounting Standards No. 8 on Security Return Behavior. Stamford, Conn. Financial Accounting Standards Board, 1978. Eaker, Mark R. The Numeraire Problem and Foreign Exchange Risk, Journal of Finance, May 1981, pp. 419-427. Feiger, George, and Bertrand Jacquillat. International Finance: Text and Cases. Boston: Allyn amp Bacon, 1981. Giddy, Ian H. Why It Doesnt Pay to Make a Habit of Forward Hedging, Euromoney, December 1976, pp. 96-100. Hekman, Christine R. Foreign Exchange Exposure: Accounting Measures and Economic Reality, Journal of Cash Management, FebruaryMarch 1983, pp. 34-45. Hodder, James E. Hedging International Exposure: Capital Structure Under Flexible Exchange Rates and Expropriation Risk, unpublished working paper, Stanford University, November 1982. Jacque, Laurent L. Management of Foreign Exchange Risk: A Review Article, Journal of International Business Studies, SpringSummer 1981, pp. 81-101. Lessard, Donald R. International Financial Management. Boston: Warren, Gorham and Lamont, 1979. Levi, Maurice. Financial Management and the International Economy. New York: McGraw Hill, 1983. Logue, Dennis E. and George S. Oldfield. Managing Foreign Assets When Foreign Exchange Markets are Efficient, Financial Management, Summer 1977, pp. 16-22. Makin, John H. Portfolio Theory and the Problem of Foreign Exchange Risks, Journal of Finance, May 1978, pp. 517-534. Myers, Stewart C. The Search for Optimal Capital Structure, in Joel Stern and Donald Chew, eds, The Revolution in Corporate Finance, Second edition. Cambridge, Mass. Blackwell Publishers, 1992. 1. Copyright copy1992 Ian H. Giddy and Gunter Dufey. Forthcoming in: Frederick D. S. Choi, ed. The Handbook of International Accounting, to be published by John Wiley amp Sons. 2. For a review of the literature see R. Naumann-Etienne, A Framework for Financial Decisions in Multinational Corporations--A Summary of Recent Research, Journal of Financial and Quantitative Analysis, November 1974, pp. 859-874 and more recently Maurice Levi, Financial Management and the International Economy (New York: McGraw-Hill, 1983), Ch. 13. 3. D. Snijders, Global Company and World Financial Markets, in Financing the World Economy in the Nineties, J. J. Sijben, ed. (Dordrecht, Netherlands: Kluwer Academic Publishers, 1989) 4. Note that when we say the forward rate follows a random walk, we mean the forward for a given delivery date, not the rolling 3-month forward. Since the only published measure of a forward rate for a given delivery date is the price of a futures contract, the latter serves as a proxy to test the proposition that the forward rate should fluctuate randomly. 5. See Gunter Dufey and Ian H. Giddy, International Financial Planning: The Use of Market-Based Forecasts, California Management Review, XXI, 1 (Fall 1978), pp. 69-81. Adapted from The Handbook of International Accounting and Finance, Frederick D. S. Choi, Editor (Wiley) Ian H. Giddy, Professor of Finance New York University Stern School of Business 44 West 4th Street, New York 10012 Tel 212 998-0332 Fax 212 995-4233
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