What kind of risk ？

1. What kind of risk？ • Anything affecting demand and supply • Output prices • Input prices 胡星陽 - 風險管理

2. 1. What kind of risk？ • Foreign exchange • Historical NT$/US$ rate (1980-2001) 胡星陽 - 風險管理

3. 1. What kind of risk？ • Foreign exchange • Transaction risk （Current and future transactions） • Sales is in US$, NT$ received will change when FX changes • Elasticity is 1 • T＝eU，T is in NT$, U is in US$, e is FX rate • ΔT/T=Δe/e • Economic risk • When NT$ appreciates（from NT$42/US$1 to 38）, importers will have a lower cost in NT$, domestic companies will lose competitive advantages and profit will drop 胡星陽 - 風險管理

4. 1. What kind of risk？ • Interest rates • Historical 31-90 days Commercial Paper rate in Taiwan (1980:11-2001:9) 胡星陽 - 風險管理

5. 2. Factors affecting the extent of risk • Operating dimension • Products attributes • Production method（Operating leverage） • Financing method（Financial leverage） 胡星陽 - 風險管理

6. 3. How to deal with risk？ • Take calculated risk • Try to reduce the probability or the payoff of failure • British Petroleum chooses not to insure externally against losses above $10 million. • Weak competition, high insurance permiums • Low probability of loss • Enough capital in the case of loss 胡星陽 - 風險管理

7. 3. How to deal with risk？ • Reduce risk with operating decision • Strategic move • Coca-Cola develop the franchise bottling system and reduce the uncertainty from bottlers (Teisberg, 1993) • Microsoft develops browser and bundles with Windows95 • Know your markets • J.P. Morgan's John Miller is strictly a numbers guy. Although he often goes to the movies, he doesn't read scripts, doesn't care about plots, and doesn't worry about which stars have signed on -- unless they threaten to bust the budget. (Business Week, March 7, 2005) • He relies instead on a sophisticated financing model fueled by data on how more than 300 films performed at the box office. It allows him to tune out the noise and focus on what really counts in a movie's success. • What business plan: its budget size, financial partners, release date, genre, distribution schedule, prospects in foreign, DVD, and other markets. 胡星陽 - 風險管理

8. 3. How to deal with risk？ • Reduce risk with operating decision • Monitor • To combat Hollywood's spendthrift ways, Miller’s loan documents are loaded with covenants, covering everything from limiting how much of the bank's money a producer can spend on a single movie to requiring his O.K. before producers add financial partners or foreign distributors. Miller insists on quarterly reports to make sure producers keep their promises, often sending in audit teams to double-check. "He makes you work for your money," says Charlie Lyons, CEO of Beacon Pictures, which has a $200 million credit line with Morgan. "It imposes discipline on you." • Choose appropriate production technology • Choose capital intensive technology to reduce the impact of exchange rate on labor cost 胡星陽 - 風險管理

9. 3. How to deal with risk？ • Reduce risk with operating decision • Reduce risk over time • To get more information • Pursuing a project in stages, e.g., test market, to collect more information or to wait for uncertainty to be resolved • Staged financing in venture capital • Invest in flexibility • For example, buy machines that can use different energies 胡星陽 - 風險管理

10. 3. How to deal with risk？ • Reduce risk with operating decision • Diversification • Do R&D in different technologies, e.g, GM in electric car • Only large firms can afford to spread risk • J.P. Morgan's John Miller issues loans for slates of films at a studio -- 5 to 15 at a time -- not single flicks. He figures 3 of 10 movies will do well and one will hit the jackpot, offsetting losses from the flops. "If you get up to 15 films, it's hard to lose money on a slate," says Miller. (Business Week, March 7, 2005, Multibillion Dollar Baby) • Matching risk • Matching the currency for revenue and cost 胡星陽 - 風險管理

11. 3. How to deal with risk？ • Reduce risk with financial decision • Risk sharing with claim holders • Risk sharing with more people • Syndicated loan • Many shareholders • Risk sharing with input provider • Builder and land owner • Nissan and Yulon share FX risk • A Brazilian mining company linked its price of electricity to the price of their product 胡星陽 - 風險管理

12. 3. How to deal with risk？ • Reduce risk with financial decision • Risk sharing with claim holders • Risk sharing with bondholders • In mid 1980, Zambian cotton grower expanded its operation using a loan whose interest rate is linked to international price of cotton • A West African gold mining company borrowed gold and repaid with gold. Although it is denominated in gold, the transaction actually took place in dollar equivalent 胡星陽 - 風險管理

13. 3. How to deal with risk？ • Reduce risk with financial decision • Risk transfer • Cost of risk transfer • British Petroleum choose not to insure externally against losses above $10 million • Insurance • Used in event type of risk: Hurricane, earthquake 胡星陽 - 風險管理

14. 3. How to deal with risk？ • Reduce risk with financial decision • Risk transfer • Financial products • Used in continuous risk: price change • Sometimes, it’s used together with a loan agreement • In 1989, the first corporate loan after the Mexican default in 1982. It includes a fixed rate international loan, a copper sales agreement, and a copper swap. • Sales: A promise of future delivery (for the life of the loan) of a fixed amount of copper at the future spot price. It ensures the repayment of the loan. • Swap: Converts the market price into a fixed price • In 1990, the company entered another loan that includes a secured loan and a hedging program (including a swap) 胡星陽 - 風險管理

15. 3. How to deal with risk？ • Reduce risk with financial decision • Matching risk • Matching the duration of asset and liability 胡星陽 - 風險管理

16. 4. Hedging with financial instruments • Futures or Forwards • Contract • Current FX rate is NT$35（Pc）, buyer will purchase US$1 million with a FX rate PF after one month • Currency 1972, interest rate 1975 胡星陽 - 風險管理

17. 4. Hedging with financial instruments • Futures or Forwards • Payoff at maturity for buyer PF FX at maturity 胡星陽 - 風險管理

18. 4. Hedging with financial instruments • Futures or Forwards • Hedging with futures • 1-to-1 hedging • Minimum risk hedging：Number of futures used for each spot position（HR）=-ΔPc/ΔPF 胡星陽 - 風險管理

19. 4. Hedging with financial instruments • Swap • Contract • Currency 1982, interest rate 1982 • Current FX rate is NT$35（Pc）, buyer will purchase US$1 million each year for the following 5 years, with a FX rate PF • Equivalent to 5 futures contracts 胡星陽 - 風險管理

20. 4. Hedging with financial instruments • Options • Contract • Call • Put • Currency 1982, interest rate 1982 胡星陽 - 風險管理

21. 5. Hedging objects • Asset or liability hedging • Oil inventory hedging • Foreign currencies accounts receivable hedging • Commitment hedging • Contracts that had signed require the firm to pay foreign currencies • Future transactions hedging • Hedging or speculation? 胡星陽 - 風險管理

22. 6. Derivative usage in TaiwanSource: Shu, Pei-Gi, and Hsuan-Chi Chen, 2003, The Determinants of Derivatives Use: Evidence from Non-Financial Firms in Taiwan, Review of Pacific Basin Financial Markets and Policies 6:4 胡星陽 - 風險管理

23. 6. Derivatives usages • U.S. and Germany • Survey in 1995 (U.S) and 1997 (Germany) (Bodnar and Gebhardt, 1998) • 78% of German firms using derivatives compared to 57% of US firms. • In both countries, foreign currency derivative usage is most common, followed closely by interest rate derivatives, with commodity derivatives a distant third. 胡星陽 - 風險管理