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MBSP 0354 International Finance

MBSP 0354 International Finance. Lecture 5 03 NOV 09. DEVISING A FOREIGN EXCHANGE MANAGEMENT STRATEGY. Objectives of Lecture. Introduce the Role of the Treasurer Discuss: External FX Management Strategies Internal FX Management Strategies. Readings:. Buckley: Chapter 10 Chapter 11

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MBSP 0354 International Finance

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  1. MBSP 0354International Finance Lecture 5 03 NOV 09

  2. DEVISING A FOREIGN EXCHANGE MANAGEMENT STRATEGY

  3. Objectives of Lecture • Introduce the Role of the Treasurer • Discuss: • External FX Management Strategies • Internal FX Management Strategies

  4. Readings: • Buckley: • Chapter 10 • Chapter 11 • Chapter 32 - 32.3 to 32.5

  5. Centralise or Decentralise • Centralise: • Take Decisions at “Group” Level • Maybe Cheaper • Maybe more Efficient • Decentralise: • Take Decisions at “Subsidiary Company” Level • Maybe more in Line with Devolved Management Responsibility

  6. Centralise or Decentralise

  7. Enter – The Treasurer • Internal BANKER: • NOT Accountant • Job is to Make Best Use of Internal and External Banking Facilities and Techniques • Profit Centre or Cost Centre

  8. The Treasurer – Job Description • Identify Exposure: • Transaction Exposure • Translation Exposure • Commercial / Economic Exposure • Manage Exposure • Manage Cash

  9. Transaction Exposure • Arises from Changes in Spot Rate • Affects: • Sales Revenue • Cost of Sales • OverheadCost • A Threat to the Profit & Loss Account

  10. Transaction Exposure • We Export Washing Machine to Switzerland: • Spot Rate CHF 1.90 = GBP 1 • Sales Price = GBP 200 = CHF 380 • Costs Total GBP 170 • Profit = GBP 30

  11. Transaction Exposure • If Spot Rate Becomes CHF 2.20 = GBP 1: • Sales Revenue = CHF 380 = GBP 172.72 • Costs = GBP 170.00 • Profit = GBP 2.72 • Profit Falls by c. 91%

  12. Translation Exposure • Arises from Changes in Spot Rate • Arises from Holding: • Assets • Liabilities • A Threat to the Balance Sheet

  13. Translation Exposure • Purchase Office Block / Service Centre for CHF 2,000,000 • Spot Rate CHF 1.90 = GBP 1: • Value is GBP 1,052,630 • 2 years Later: • Value is Still CHF 2,000,000 • Spot Rate is CHF 2.20 = GBP 1 • Value is GBP 909,090 • Translation Loss is GBP 143,540

  14. Commercial / Economic Exposure • Arises from Changes in Spot Rate • Results in a Gain / Loss of Market • Note Difference between Concept of: • Commercial Exposure • Economic Exposure • “Threat to Long-Term Cash Flow”

  15. Commercial / Economic Exposure • We Export Washing Machine to Switzerland: • Our Price is GBP 200 • At CHF 1.90 = GBP 1: • Our Price is CHF 380 • German Competitor Sells at CHF 420

  16. Commercial / Economic Exposure • Spot Rate Changes to CHF 2.25 =GBP 1 • EUR / CHF Spot Rate Unchanged • Our Price Changes to CHF 450 • German Co’s Price Still CHF 420

  17. Internal Techniques • Netting • Matching • Leading & Lagging Balances • Determining Currency of Invoice

  18. Netting • Netting End of Period Balances: • Same Currency • Parallel Currency • Simple Example: • A Owes B USD 10,000,000 • B owes A USD 8,000,000 • Net Debt is from A to B • Net Debt is USD 2,000,000 • Real Life Examples much more Complicated

  19. Parallel Currency • Currencies Closely Linked in their Market Performance • 2 year Chart - Spot Rate Euro (EUR) v. Danish Krone (DKK)

  20. Matching • Matching Inflows and Outflows of Same Currency • Dates of Individual Receipts / Payments Altered • Simple Example: • A is due to Receive EUR 1,000,000 on 25 JAN 10 • A is due to Pay EUR 1,000,000 on 05 FEB 10

  21. Leading and Lagging • Speeding Up (Leading) Settlement of Receipt / Payment • Slowing Down (Lagging) Settlement of Receipt / Payment • Normally on Inter-Company Items: • Can Also be on External Items (Risky)

  22. Leading and Lagging • Useful in Countries with Volatile Rates • Some Governments Often Impose Fixed Payment Dates • Can also be used for Tax Planning: • Shifting Revenues / Costs

  23. Leading and Lagging • A (Co. in Ruritanian) has to pay 10 m. Ruritanian Pesos (RUP) in one Month • Current Spot Rate RUP 10 = GBP 1 • Current Value GBP 1,000,000 • Exp. 10% Devaluation of RUP within Month (New Rate RUP 11 = GBP 1) • Expected Value GBP 909,090 • Pay now (Lead) and Save GBP 90,910

  24. Determining Invoice Currency • Do not Invoice in Weak Currency: • Use Strong Currency • Prices in Russia Quoted in USD not Russian Roubles (RUR) • Could Invoice in Strong Currency to take Advantage of Currency Gains

  25. External Techniques • Forward Markets • Currency Futures Markets • Currency Options Markets • Currency Swaps • Factoring Foreign Debts: • Selling Invoice to Factor (Bank)

  26. Back to Exposure • A Company only has ONE net Exposure per Currency • Treasurer’s Job to Manage this

  27. Cost Control • Use Internal Techniques Whenever Possible: • Replace External Techniques • Cheaper • Offsets Cost of Treasurer • Contributes to Profit

  28. Information Flows • Treasurer Needs Information on: • Cash Balances: • In ALL Currencies • Cash Flows Through Trading • Cash Requirements for Capital Expenditure

  29. Information Report Cycle • Some Information Needed Daily: • Cash Balances • Cash Expected • Cash Required • Other Reporting Frequencies: • Capital Expenditure Requirements

  30. Behavioural Issues

  31. Behavioural Issues • Given Need for: • Responsibility • Accountability • Control • How do you Exercise Central Control ?

  32. Behavioural Issues • Answer - Persuasion • Treasurer’s Rates Always Best • Treasurer’s Costs Always Lowest • What is in Company’s Interest is also in Subsidiary’s Interest

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