“Wide German Protests Planned Today in Dispute on Sick Pay” ( New York Times , 10-24-96)

1. “Wide German Protests Planned Today in Dispute on Sick Pay”(New York Times, 10-24-96) • “IG Metall, Germany’s largest union, said today that big rallies were planned nationwide on Thursday to protest possible cuts in sick pay, after the collapse of talks with employers aimed at resolving the matter.”

2. “Wide German Protests Planned Today in Dispute on Sick Pay”(New York Times, 10-24-96) • “Given German tradition, it is difficult to see companies in one industry having many different policies.” Wages and labor policy in Germany have traditionally been settled through industry-wide contracts, not company by company.

3. “Wide German Protests Planned Today in Dispute on Sick Pay”(New York Times, 10-24-96) • German industry wants to reduce sick-pay coverage to 80 percent of base wages, in line with a new legal minimum passed last month. Until now, sick pay has been 100 percent of wages plus average overtime.

4. “Wide German Protests Planned Today in Dispute on Sick Pay”(New York Times, 10-24-96) • Days after Parliament passed the legislation on Sept. 13, Daimler-Benz announced that it would cut sick pay for its 220,000 German employees. A number of large companies followed with similar announcements.

5. “Sweden’s cradle-to-grave welfare starts to get ill”[Intl. Herald Tribune, 9-25-02] • “…one in 20 Swedish workers were on sick leave for more than a week last year, double the European Union average, and that paid sick leave averaged nearly 25 days, up from 14 days in 1998.”

6. “Sweden’s cradle-to-grave welfare starts to get ill”[Intl. Herald Tribune, 9-25-02] • “An average of 430,000 Swedish employees, 10 percent of the country’s work force is on sick leave at any given time.”

7. “Sweden’s cradle-to-grave welfare starts to get ill”[Intl. Herald Tribune, 9-25-02] • “The government pays a benefit equal to 80 percent of a person’s salary during sick leave, no matter how long, and an additional 10 percent in what is called “contract insurance” for the first three months.”

8. Average number of days a Swedish worker is on sick leave

9. Measuring and Managing Translation and Transaction Exposure[Shapiro: Chapter 9]

10. Hedging • “ ... establishing an offsetting currency position ... • ... whatever is lost or gained on the original currency exposure ... • is exactly offset by a corresponding foreign exchange gain or loss ... • on the currency hedge.”

11. Hedging • “Regardless of what happens to the future exchange rate ... • hedging locks ina dollar (home currency) value for the currency exposure.”

12. Managing Transaction Exposure • Which exposures to manage? • Those that are: • large in size • involve volatile currencies • extend over long periods of time

13. Managing Transaction Exposure • Which exposures to manage? • How to manage the position? • How much of the position to hedge? • Which exposure-reducing techniques to employ?

14. Transaction Exposure • Committed to a foreign currency- denominated transaction • Future foreign currency cashinflow or outflow • Risk: exchange rate may vary • Hedge: offsetting cash flows

15. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting • Pricing decisions • Exposure netting • Currency risk sharing • Currency collars • Currency options

16. General Electric Example • Jan. 1: contract for € 10 million • Dec 31: payment to be received • Current spot price: € =$1.3382 • One-year forward: € =$1.2800 • What are the risks to GE? • How would you manage those risks?

17. Managing Transaction Exposure • Forward market hedge: • if long, sell currency forward • if short, buy currency forward • Fix the dollar value of future foreign currency cash flow

18. GE Forward Market Hedge

19. GE Forward Market Hedge

20. GE Forward Market Hedge

21. GE Forward Market Hedge

22. Managing Transaction Exposure • Forward market hedge • Money market hedge

23. Money Market Hedge • Simultaneous borrowing and lending in ... • two different currencies to ... • lockin the dollar value of a future foreign currency cash flow.

24. Money Market Hedge • € interest rate = 15% • $US interest rate = 10% • GE borrows € 8.70 (10/1.15) million for one year • Convert € into $11.64 million (8.7 X 1.3382)

25. Money Market Hedge • Invest $11.64 million for one year @ 10% • On 12/31, GE receives $11.64 x 1.10 = $12.8 million • GE collects its receivable from Lufthansa: € 10 million • GE repays the € 10 million it owes (€ 8.7 x 1.15)

26. GE Money Market Hedge

27. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting

28. Risk Shifting • Price transaction in dollars • Doesn’t eliminate currency risk • Shifts it from GE to Lufthansa • Zero-sum game

29. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting • Pricing decisions

30. Pricing Decisions • € 10,000,000 X $1.3382 = $13,382,000 • What is the “real worth” of the contract with Lufthansa? Why? • € 10,000,000 X $1.28 = $12,800,000 • $13,382,000 / 1.28 = € 10,454,688

31. Pricing Decisions • “The general rule on credit sales overseas is to convert between the foreign currency price and the dollar price by using the forward rate, not the spot rate.”

32. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting • Pricing decisions • Exposure netting

33. Exposure Netting • “...the net gain or loss on the entire currency exposure portfolio is what matters, rather than the gain or loss on any individual monetary unit.”

34. Exposure Netting • Portfolioapproach to hedging • Portfolio risk less than the sum of individual risk positions

35. Exposure Netting[Possible outcomes] • Offset long and short positions in the same currency • Offset long and short positions in positively correlated currencies • Offset long (or short) positions in negatively correlated currencies

36. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting • Pricing decisions • Exposure netting • Currency risk sharing

37. Currency Risk Sharing • Imbedded hedge contract • Price adjustment clause • Base price adjusted for certain exchange rate changes • Risk is shared beyond “neutral zone”

38. Currency Risk Sharing • Base rate: € 1 = $1.33 • Neutral zone: $1.30 - $1.36 • What happens at € 1 = $1.22? • Rate used = $1.29 : € 1 • $1.29 = ($1.33 – (.08 / 2)) • € 10,000,000 X 1.29 = $12,900,000 • $12,900,000 ÷ $1.22 = € 10,573,770

39. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting • Pricing decisions • Exposure netting • Currency risk sharing • Currency collars

40. Currency Collars[“Range Forward”] • GE accepts some but not all risk • GE buys protection outside a range • Range: € = $1.28 - $1.38 • If e1 < $1.28, then RF = $1.28 • If $1.28 ≤ e1≤ $1.38, then RF = e1 • If e1 > $1.38, then RF =$1.38

41. Managing Transaction Exposure • Forward market hedge • Money market hedge • Risk shifting • Pricing decisions • Exposure netting • Currency risk sharing • Currency collars • Foreign currency options

42. Foreign Currency Options • Uncertain foreign currency flows • Example: competitive bid contract • GE buys a € 10 million put option ($1.28/€) for $100,000 • GE loses bid; maximum loss = $100,000 • GE wins bid; e1 > $1.28; let option expire, sell at spot