IBF Ch10&11 - Lecture 8 Ch10: Managing Transaction...

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Unformatted text preview: Lecture 8 Ch10: Managing Transaction Exposure to Currency Risk Transaction exposure to currency risk is defined as change in the value of monetary (contractual) cash flows due to an unexpected change in exchange rates. Managing Transaction Exposures Internally Geographically diversified operations (MNCs) can provide a natural hedge of currency risk. Multinational Netting Leading and Lagging Multinational Netting This is the process in which currency transactions from within the firm are offset and then netted . The multinational treasury can identify the exposure of the corporation as a whole by consolidating and netting the exposures of the firms operating units. (Book example page 221) I.e. The U.S. parent receives $140,000 and pays $110,000, for a net cash inflow of $30,000 Treasury can minimize its transaction costs by coordinating the cash flows of its operating units. Actual payments can be transferred in whatever currencies the operating units prefer, with the corporate treasure acting as an internal bank to minimize the firms internal and external market transactions . Note : In contract to MNCs, importers and exporters (i.e. separate companies for importing and exporting) usually cannot offset their exposures internally. Would need a U.S. dollar inflow to offset a U.S. obligation could create an exporting business to offset an importing business (to create a natural hedge) this is stupid to do just to hedge, one could hedge exposure much more easily through financial markets. Hedging decisions are centralized in the corporate treasury to minimize the firms overall risk exposures and hedging costs. o Consolidating and netting exposures rather then hedging each individual exposure allows managers of individual units to hedge as needed , while avoiding the costs (commissions and bid ask spreads) of hedging in external markets only need to hedge net exposures . Treasury shouldould charge market prices to the individual operating units for hedging within the firm therefore reflects true cost of hedging . Centralized treasury management promotes operational efficiency and reduces the risk that a divisional manager will put the entire company at risk with an ill-advised or redundant financial market hedge that could go to shit. Leading and Lagging This is the process of altering the timing of cash flows to reduce transaction exposure. Like multinational netting, leading and lagging works best when the currency needs of individual units within the MNC offset one another. Lead : bringing receivables forward. How? Factor: Sell receivables to bank cost = discount Borrow: Borrow early costs = interest transfer from transaction exposure risk to credit risk Renegotiate: ask customer to pay earlier cost = discount All-in-cost is the interest rate implied by: (FV outflow / Inflow) 1. One would compare all-in-cost of each option and take the cheapest alternative....
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This note was uploaded on 08/06/2011 for the course FIN 3616 taught by Professor Henry during the Three '11 term at University of New South Wales.

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IBF Ch10&11 - Lecture 8 Ch10: Managing Transaction...

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