GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS

1. GLOBAL ACCOUNTING AND CONTROL: A MANAGERIAL EMPHASIS Sidney J. Gray, University of New South Wales Stephen B. Salter, University of Cincinnati Lee H. Radebaugh, Brigham Young University Slides Prepared by: Jennifer Anne Salter

2. CHAPTER TWO FOREIGN CURRENCIES AND EXCHANGE RISK MANAGEMENT

3. INTRODUCTION This chapter explains: terminology of foreign exchange; major foreign exchange products; major types of foreign exchange risks; alternative approaches to foreign exchange risk management.

4. FOREIGN EXCHANGE RISKS AND SOLUTIONS - Import for Cash Problem Let’s explain with an example. Your firm, Alamo Computers of San Antonio, Texas, USA, wishes to buy some computer motherboards. Here are three suppliers with prices in their local currency.

5. FX RISKS & SOLUTIONS CONT’D- An Import for Cash Problem

6. FX RISKS & SOLUTIONS CONT’D - An Import for Cash Problem What do we do now? Calculate the price in a common currency (US$ would be logical since you are US based). How do we do that? Get the price in local currency (LCP) for each location from the table. Divide the LCP by the LC/US$ exchange rate to get the US$ Price. See Table 2.1/2.2 or http://www.bmo.com/economic/.

7. Lets look at 2.1 First it’s a word file

8. FX RISKS & SOLUTIONS CONT’D - An Import for Cash Problem

9. Lets change the number to Today's rates from BMO

10. FOREIGN EXCHANGE RISKS AND SOLUTIONS - Import for Credit What if you want to buy on credit? Is Singapore still the cheapest supplier? Will the exchange rate stay the same? Can you protect yourself from fluctuations in the exchange rate?

11. FOREIGN EXCHANGE RISKS AND SOLUTIONS - Import for Credit Problem McBoards offers 6 mos. interest free credit. For the others you must borrow at 1% per month. However, the British Pound is a floating currency.

12. The British Pound Floats

13. FOREIGN EXCHANGE RISKS AND SOLUTIONS - Import for Credit Problem You can neutralize the risk of the British £ changing in value by using a derivative. FX Derivatives can include forward contracts, futures, swaps and options.

14. Derivatives - Forward Contracts A Forward Contract is a contract between a foreign currency trader and a client for the future sale or purchase of foreign currency at a forward rate. The Forward Rate is a contractual rate between the FX trader/client for the amount of currency A needed to acquire one unit of currency B at a fixed future date. (Tbl 2.1)

15. Derivatives - Forward ContractsExtract from Table 2.1 British Pound Per Dollar Spot .6054 One Month Forward .6054 Three Months Forward .6051 Six Months Forward .6053

16. Derivatives - Forward Contracts Table 2.3 shows the impact of applying the information on forward and interest rates to the purchase of boards. The Singapore $ rate assumes that you have to pay cash spot for the purchase from Singapore.

17. Derivatives - Forward Contracts

18. Derivatives - Forward Contracts From the pervious table we can conclude: McBoard’s initial US$ price is higher than other suppliers; A deferred payment option with a forward contract makes the British product a great deal more attractive. Lets redo this for today’s rate in $/FC Now let’s talk about other methods of containing FX risks.

19. At Today's Rates

20. Derivatives - Futures, Swaps and Options A Future is a highly standardized foreign exchange contract written against the exchange clearing house for a fixed number of foreign currency units and for delivery on a fixed day. A Swap is a simultaneous spot and forward transaction.

21. Derivatives - Futures, Swaps and Options Continued An Option is the right to trade foreign currency at a given exchange rate on or before a given date in the future. There are two types of options: American Options - exercised during a stipulated period. European Options - exercised at a specified end date.

22. Derivatives - Futures, Swaps and Options Continued Options have the following terms: An up front fee for the right to buy or sell a fixed amount of foreign currency. This is given in US cents per foreign currency unit. This is in addition to the actual cost of the foreign currency. Tables 2.4-2.6 in your text contain an example

23. Lets look at some options http://www.cme.com/market/quote.html

24. Major World Currency Markets Markets cover almost 24 hours, starting with Auckland which is 14-16 hours ahead of Ohio, ie., if it’s 4pm in Cincinnati, it’s 11am the next day in Auckland. Tokyo: Cincinnati + 13 hours. About 15% of total volume Hong Kong & Singapore: Cincinnati + 11 and 12 hours respectively. Together roughly equal to Tokyo in volume.

25. Continued: European Markets: London is the largest market. Cincinnati + 5 hours. About 25% of total world market volume Other markets include Frankfurt and Zurich North American Markets: New York is the second largest market. Other markets include Chicago, San Francisco and Toronto.

26. Continued: NOTE: Over 90% of all transactions include the US$ as one part, e.g., DM/$, etc.

27. - Selling at a Premium or Discount Applies to Forwards/Futures PREMIUM -IF the quotation of the currency in the denominator, e.g., £ in a $/£ is greater for delivery in the future (forward) than for delivery now (spot), that currency is at A

28. Premium or Discount PREMIUM. IF THE SPOT FOR £ IS $1.5 PER £ AND THE FORWARD QUOTE IS $ 1.60 PER £. Note : In the example $ AT A DISCOUNT.

29. OPTIONS: COMPUTING THE COST AND BENEFIT OF AN OPTION This exercise first calculates the cost of an option and then its potential benefit. The example is for 30-day option to buy Japanese Yen using US Dollars. 30 days will take us to July.

30. Computing Option Cost The rate we want to buy the Yen at is $.00775 per ¥. The premium charged to execute such a contract is 1.64 hundredths of a cent per ¥ covered (dollars .000164 per ¥).

31. Computing AN Option Contracts come in blocks of ¥6,250,000. The cost of a contract is as follows: Premium at .000164$/¥ *6,250,000 $1,025 Brokerage Cost (admin. fee) $ 25 Total Cost per Contract $1,050

32. A TYPICAL OPTION SCENARIO Covering ¥ one hundred million (100mm). How many contracts do we need? 100 mm ¸ 6.25mm = 16 Cost of cover: 16 x $1,050 = $16,800

33. Option Scenario : Costs Potential benefit: If the value of the ¥ exceeds $0.00775 per ¥ plus the transaction cost, we can exercise the option and sell the ¥ for a profit.

34. Option Scenario : Costs Buy 100mm ¥ at $.00775/¥ $775,000 Option Cost 16 contracts $16,800 Additional admin. fees on exercising $400 Total $792,200

35. Option Scenario : Benefits If we sell the ¥ at .0080 $/¥, we have a profit of $7,800. At .0090 $/¥, the profit is $107,800.

36. FOREIGN EXCHANGE RISK &THE MULTINATIONAL ENTERPRISE The Multinational Enterprise is often referred to as an MNE.

37. Classifying Risk and Exposure There are 3 types of foreign exchange exposure: Transaction Translation Economic

38. Classifying Risk and Exposure - Transaction Exposure Transaction Exposure arises because we do not have a method of accounting for multiple currencies Examples of Transaction Exposure include purchasing or selling on credit, goods or services where the price is stated in a foreign currency.

39. Classifying Risk and Exposure - Transaction Exposure How do we handle inherent risks? Prepare a separate budget for international cash flows. This will allow you to assess if the volume of unhedged cash flows is significant.

40. Classifying Risk and Exposure - Translation Exposure Translation Exposure is when assets and liabilities on a balance sheet in one currency, have to be re-expressed in another currency . Accounting for this has caused discord between financial regulators and the business community.

41. Classifying Risk and Exposure - Economic Exposure Economic Exposure involves uncontracted and unplanned changes in future cash flows which are the result of changes in exchange rates.

42. Classifying Risk and Exposure - Economic Exposure Cont’d Any decisions based on economic exposure are primarily long term. These decisions include choosing market and production facility locations.