f55 ER Ch08 Transaction Exposure

f55 ER Ch08 Transaction Exposure - 11/30/2010 Management of...

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11/30/2010 1 8 Chapter Eight Management of Transaction Exposure Chapter Objective: This chapter discusses various methods available for the management of transaction exposure facing multinational firms. This chapter ties together chapters 5, 6, and 7. 8-0 Chapter Outline Differentiate between Transaction, Operating, and Translation Exposure Forward Market Hedge Money Market Hedge Options Market Hedge Cross-Hedging Minor Currency Exposure Hedging Contingent Exposure Hedging Recurrent Exposure with Swap Contracts 8-1
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11/30/2010 2 Chapter Outline (continued) Hedging Through Invoice Currency Hedging via Lead and Lag Exposure Netting Should the Firm Hedge? What Risk Management Products do Firms Use? 2 8-2 Forward Market Hedge If you are going to owe foreign currency in the future, agree to buy the foreign currency now by entering into long position in a forward contract. If you are going to receive foreign currency in the future, agree to sell the foreign currency now by entering into short position in a forward contract entering into short position in a forward contract. 8-3
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11/30/2010 3 Forward Market Hedge of Payable: Example You are a U.S. importer of Italian shoes and have just ordered nex year’ inventory A paymen of €100M i ordered next year s inventory. A payment of €100M is due in one year. You will need €100M in one year. You don’t know what the price of euro will be in the spot market, one year later (S 1 ). You do not know how many dollars you will need to cover your €100M payment You have foreign exchange risk exposure. How do you eliminate this risk? 8-4 Forward Market Hedge of Payable: Example Suppose, this is the market condition right now : The current price of euro in the spot rate (S) = $1.43 One year, forward rate for euros (F) = $1.50 US Interest Rate ( i H )=8% Interest rate in Euro zone ( i F )= 3% If you buy a one year forward contract for €100 million, you wil have to pay $150 million fo i in on yea you will have to pay $150 million for it in one year. If one year later, the price of euros in the spot market (S 1 ) turns out to be $1.80, then you saved (gained) $30 million. If S 1 is $1.20, then you lost $30 million. 8-5
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11/30/2010 4 Gains & Losses from Forward Market Hedge of Payable: Example Long forward If you agree to buy €100 million at a price of $1 50 € S 1 $1 80 € $0 $30m $1 20 € $1.50/€, you will make $30 million if the price of the euro reaches $1.80. 6 $1.50/€ $1.80/€ $1.20/€ –$30m If you agree to buy €100 million at a price of $1.50 per pound, you will lose $30 million if the price of the euro falls to $1.20/€. 8-6 Gains & Losses from Forward Market Hedge of Payable: Example S Cash Flow: Cash Flow: Gain / Losses relative to 1 Unhedged Position Forward Hedge Unhedged position 1.20 - $120,000,000 - $150,000,000 - $30,000,000 1.35 - $135,000,000 - $150,000,000 - $15,000,000 1.50 - $150,000,000 - $150,000,000 0 165 $165 000 000 $150 000 000 $15 000 000 8-7 1.65 - $165,000,000 - $150,000,000 $15,000,000 1.80 - $180,000,000 - $150,000,000 $30,000,000
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11/30/2010 5 Forward Market Hedge of Receivable: Example You are a U.S. exporter of chemicals expecting a payment o €75M from German pharmaceutica firm in one of €75M from a German pharmaceutical firm in one year. You will need to convert €75M into $ in the spot market in one year. You don’t know what the price of
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f55 ER Ch08 Transaction Exposure - 11/30/2010 Management of...

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