Taking the Foreign Currency Risk out of Foreign Investment

1. Asia Pacific Business Outlook University of Southern CaliforniaMarch 27, 2007 Presented By: David Gopal, Wells Fargo Taking the Foreign Currency Risk out of Foreign Investment

2. Managing Foreign Exchange Risk “We experienced an unfavorable impact to other international revenues due to the strengthening of the dollar relative to other foreign currencies primarily the Euro and the Japanese Yen.”Google Inc. 12/31/05 10-K “Foreign exchange had a negative 1% impact on net sales growth, primarily due to the strengthening of the U.S. dollar relative to the Euro, British Pound and Japanese Yen.”Procter & Gamble Co. 6/30/06 10-K Overseas investing has its own unique set of risks and foreign exchange is one of the most prevalent!

3. Table of Contents • Overview of Hedging Foreign Currency • Hedging Foreign Exchange Risk • Global Rate Environment – Past, Present and Future

4. Overview of HedgingForeign Currency

5. The Foreign Currency Market • Scope of foreign exchange market • Volume over $2 Trillion / day • Expansion of product type • Spot, forwards • Options of all types • Cross-currency swaps • Hybrids • The participants • Commercial and investment banks (providers) • Companies (hedgers) • Central Banks / Governments • Private Equity & hedge funds (hedgers and speculators) • Wealthy individuals (hedgers and speculators)

6. The Unintended Foreign Currency Position • Why are companies investing overseas? • New markets • Greater returns • Generally better or different opportunities • Any of the above situations without a foreign currency hedge equals a speculative foreign currency position.

7. Preservation of Value • Review of value • The present value of all future cash flows. • Good cash flow estimates and good investment valuation does not mean good return. If the foreign currency weakens, returns will suffer. • Transaction price • The purchase price in foreign currency OR eventual sales price in foreign currency. • An investment into Japan may perform well in local currency, but if the Yen weakens, the realized US dollar sales price will suffer.

8. Private Equity Investment Example Scenario: Private Equity Firm ABC USA purchases a Japanese Company for 1B Japanese Yen. Assumptions: • 10% annual cash flow • 25% growth at maturity • Current JPY/USD exchange rate is 118 • The exchange rate will remain constant at 118

9. Private Equity Investment Example • The future USD amounts depend on the future exchange rate • If JPY drops by 10% (to ~130) after investment….. • 1B JPY = 8.47MM USD investment today (done at initiation) • 100MM JPY = 770K USD (~77K less due to weaker JPY) • 1.25B JPY = 9.63MM USD (~1MM less due to weaker JPY) • Returns can suffer dramatically due to currency fluctuations!

10. Hedging Foreign Exchange Risk

11. Hedging Considerations • Certainty of cash flows • Timing • Amount • Risk tolerance • Return requirements • Company policy • Accounting implications • Access to markets

12. Product Considerations • Derivatives • Forwards • Options • Swaps • Structural decisions • Borrowing base • Contract currencies

13. Hedge Products • Short-dated hedges • Forwards • Provides a known USD amount against a known currency amount. • Used when there is a known currency amount to be paid (received) in the near future. • Options • Provides a worst case USD amount against a known currency amount. • Used when there is less certainty around whether there will be a currency need or to maintain upside potential. • Long-dated hedges • Cross-Currency Swaps • Converts a set of cash flow in currency to USD (or vice-versa). • Used when the exposure is long-term or perpetual in nature.

14. Product – Cross-Currency Swap • Cross-Currency Swaps (CCS) are used to convert debt from one currency to another. • CCS’s allow companies to synthetically create debt in a currency, which they may normally not be able to access. • An initial exchange is not necessary. Initial Exchange of Principal 1B JPY 1B JPY Cross-Currency Swap XYZ Corp JPY Investment USD Debt 8.47MM USD 8.47MM USD Periodic Interest Payments 3M JPY Libor + 250 bps JPY Cash Flow Cross-Currency Swap XYZ Corp JPY Investment USD Debt 3M USD LIBOR +250 bps 3M USD LIBOR +250 bps Exchange of Principal – At Maturity 21B JPY 1B JPY Cross-Currency Swap XYZ Corp JPY Investment USD Debt 8.47MM USD 8.47MM USD

15. Product – Cross-Currency Swap CCS – Synthetic Foreign Denominated Loan • From XYZ’s perspective, all USD payments (principal and interest) net to zero. They are left with a principal inflow in JPY at inception, JPY interest payments throughout the life of the transaction, and a final JPY principal repayment. This perfectly replicates a loan in JPY. In other words, XYZ has borrowed JPY synthetically. CCS – Rationale for Hedging • The initial exchange provides JPY funding for the investor. The final exchange provides a return of principal at the initial exchange rate, thereby hedging the currency risk. • Interest rate savings – It is often possible to swap to a lower non-US rate environment. In this example, the company is saving nearly 5% annually, which greatly enhances investment returns. • Access to capital – Many companies do not have access to foreign capital. Others can tap foreign markets, but not efficiently. In this case, synthetic borrowing can be cheaper. • No requirement for new capital – Companies can swap pre-existing debt to other currencies at any time.

16. Private Equity Investment Example - Hedged • Same Investment + Cross-Currency Swap • The Investor can deliver 100MM JPY / Year and 1.25B JPY in 2 years. • The Investor will receive 847K USD annually PLUS an additional amount due to the higher interest rates in the US. This additional amount is approximately 350K. So the total annual cash flow will be ~1.2MM USD. • The Investor will receive back 10.59MM USD at maturity. • Results of hedge • Currency risk is eliminated • Return is enhanced* *The enhancement is directly related to the interest differential. When hedging back to a currency with a higher interest rate, the differential can be earned.

17. Foreign Investments without Currency Risk • Not all foreign investments are foreign currency investments • Offshore manufacturing of product to be sold in USD • China or Hong Kong investment where the currency is fixed to the USD* • Desired foreign currency risk / portfolio diversification • Business risk / currency correlation – Business improves when foreign currency weakens and vice versa *There is no guarantee that these exchange rates will stay fixed in the future.

18. Global Rate EnvironmentPast, Present, Future

19. The Dollar • The dollar appreciated from 1995 - 2001 • Strong Economic Growth • Low Inflation / High Productivity • Equity Markets providing high returns • The dollar reversed from 2001 - 2004 • Equity bubble “popped” • The Fed cut interest rates drastically • The dollar reverted to the mean…and then some Source - Bloomberg

20. Historical Interest Rates • Today, Central Banks tend to have more stable and transparent policies • Rates are less “choppy” • Transparency reduces volatility • Japanese rates have not always been zero! Source - Bloomberg

21. Current Interest Rate Environment • US rates are relatively high • A long string of Fed hikes has put US rates above most other countries • The ECB has been less “hawkish” as European growth has been sluggish • The BOJ has kept rates abnormally low as the Japanese economy has suffered a long bout of economic weakness Source - Bloomberg

22. Foreign Currency Outlook • According to Bloomberg surveys: • The Euro will finish 2007 slightly stronger • The Yen will appreciate 5% • The Fed Funds rate will be 5% (one more rate cut) • According to market pricing: • The Euro will finish 2007 slightly stronger • The Yen will appreciate 4% • The Fed will cut one or two more times • Considerations • Strong US economy - Unemployment and growth 4.5% and 2.0%, respectively • Moderate Euro economy – Unemployment and growth 7.4% and 0.9%, respectively • Recovering (?) JPY economy - Unemployment and growth 4.0% and 2.3%, respectively

23. David Gopal (415) 371-6651 David Gopal is a Derivatives Specialist working for the Wells Fargo Risk Management group in San Francisco. Specializing in cross-currency swaps, David focuses on developing effective solutions for clients that minimize their foreign currency and interest rate exposure. He is also an expert on accounting regulations inherent within foreign currency and interest rate derivative structures and is able to help his clients by utilizing his strong knowledge of world currency and interest rate markets. David comes to the Risk Management team with over nine years of international finance experience gained from his tenure with a major east coast bank. He specialized in trading spot, forward and option products and was later charged with selling FX and interest rate products to corporate clients before joining Wells Fargo. David earned his MBA from the Duke Fuqua School of Business Durham, North Carolina and received a BA in economics and psychology from Claremont McKenna College in Claremont, CA. He also holds the Chartered Financial Analyst (CFA) designation.

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