More Winter ahead…

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More Winter ahead…
Foreign Currency
 What
is it?
 Why does it change?
 Risk for international managers
 How to manage risk
Linkage Between Currencies
World Market
for Euros
Price = $ / €
Price = € / $
World Market
for Dollars
S
S
€ .77 / $
$1.30 / €
D
Same “market”…different perspective.
D
Trade, FDI, and the Economy
Computers
Cash $$
Increase demand for Japanese computers – trade deficit
 Increase demand for computer inputs (components,
labor, etc.) – inflationary
 Increase demand for Yen – appreciates
 Stronger Yen increases U.S. prices – decreases demand
for Japanese computers

German Market for BMWs
Price in Euros
S
€ 100,000
D
Global Market for BMWs:
Americans want to import BMWs
Price in Euros
S
€ 110,000
€ 100,000
D
D’
World Market for Euros
Price in Dollars
S
$0.77 / €
D
World Market for D-Marks:
Americans need to convert Dollars to Euros
Price = $ / €
S
$0.74 / €
$0.77 / €
D
D’
Linkage Between Currencies
Price =
$/€
World Market
for Euros
Price =
S
$0.77/ €
€ /$
World Market
for Dollars
S
€ 1.30/$
D
D
Linkage Between Currencies
Price =
$/€
World Market
for Euros
Price =
€ /$
S
$0.74/ €
$0.77/ €
World Market
for Dollars
S S’
€ 1.30/$
€ 1.35/$
D
D’
D
Other Forces Causing Change
 Foreign
Direct Investment
 Foreign Portfolio Investment
–
–
MNCs
Government Debt Instruments
 Currency Arbitrage
and Speculation
 Governmental Intervention
–
–
–
Official and Unofficial “pegs”
International Agreements (e.g., G-7, the Euro)
Posturing (e.g., “talking” the dollar down)
Index of Swiss Franc vs. Dollar
1990 = 100
120
110
100
90
80
70
60
1980
1990
2000
Depreciating Peso
9000
8000
7000
Pesos per $
6000
5000
4000
3000
2000
1000
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
The Big Mac Index
Big Mac: in Implied
US$
PPP Rate
%
Under/
Over
Value
Big Mac:
Local F/X
Actual
F/X Rate
U.S.
$2.55
–
$2.55
–
–
EU
℮ 2.44
℮ 1.08/$
$ 2.26
℮ .96/$
- 11%
Japan
Y 253
Y 118.2/$
$ 2.14
Y 99.2/$
- 16%
England
₤ 2.99
₤ .69/$
$ 4.33
₤ 1.17/$
+ 70%
Poland
Z 1.34
Z 4.12/$
$ .32
Z .52/$
- 87%
www.economist.com
Short-term F/X Management
 Currency
–
–
–
Hedges
Forward Contracts
Options
Negotiation of Ratcheted Pricing Schedule
 Adjustment
–
–
of Prices and Target Profits
Lower foreign prices to keep market share when
home currency appreciates … lowers profit margin
Raise foreign prices to keep profit margins when
home currency depreciates … less price competitive
Today: US Dealer to Import BMWs
 Sales
–
–
–
Quantity: 100 BMW 750s
Price: € 100,000 each
Payment: Due in 3 months
 Value
–
–
–
Contract:
of Sales Contract =
€ 10.0 million
Spot Rate = $1.30 / €
$13.0 million
In Three Months: Payment is Due
Uncovered Transaction
 Euro
–
–
appreciates
New spot rate = $1.35 / €
€ 10.0 million
 Adjusted Value
–
–
of Sales Contract
“Risk penalty” = $0.05 per € traded
$13.5 million
 US
Dealer’s Loss = $500,000
Today: US Dealer to Import BMWs
Hedged Transaction
 Sales
–
–
–
Quantity: 100 BMW 535s
Price: € 100,000 each
Payment: Due in 3 months
 Value
–
–
–
–
Contract:
of Sales Contract =
€ 10 million
at 90-day Forward Rate = $1.305 / €
“Insurance premium” = $0.005 per € traded
$13.05 million
In Three Months: Payment is Due
Hedged Transaction
 Euro
–
–
appreciates
New spot rate = $ 1.35 / € (Doesn’t matter!!!)
€ 10 million
 Adjusted Value
–
–
of Sales Contract
Locked-in Forward Rate = $ 1.305 / €
$13.05 million
 Cost
of Hedge (insurance premium) = $50,000
In Three Months: Payment is Due
Hedged Transaction
 Euro
–
–
Depreciates
New spot rate = $ 1.25 / €
€ 10 million
 Adjusted Value
–
–
of Sales Contract
Locked-in Forward Rate = $ 1.305 / € (Spot better!!)
$12.5 million
 Currency
Windfall - Cost of Hedge = $450,000
Medium-Term F/X Management
 Balance
–
Match foreign assets with same level of foreign
liabilities in same currency
 Cash
–
sheet hedge
flow hedge
Match foreign A/P with A/R in same currency
Long-Term F/X Management
Shift
sourcing and procurement
Shift production
Cut costs / improve productivity
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