Shan Pin Yi Michael Utama Suphakit Sae-Ue Chanunya Pimpla Finance 570 Click icon to add picture IFC Manufacturing-Foreign Exchange Hedgi
Dec 19, 2015
Shan Pin Yi
Michael Utama
Suphakit Sae-Ue
Chanunya Pimpla
Finance 570
Click icon to add picture
IFC Manufacturing-Foreign Exchange Hedging
Agenda
Company Background IFC’s Expansion to Mexico Basie Issue and Immediate Issue Cause and Effect Diagram IFC’s Exposure Evaluate IFC’s Portfolio Hedging
Instruments Recommendation
Company Background
Canadian based company. Specialized in producing the parts used in the
production of automobiles in North American. Seatbelt. Airbag.
Two Significant Trends of IFC Increased use of outsourcing in North American
automobile manufacturing. Focusing on automobile safety invention.
Company Background
IFC’s operation based upon the implementation of proprietary technology.
No American plants owned before 1997. All U.S. acquisitions took place in 1997. IFC’s acquisition strategy is based on
large and efficiency scale that are result of the proprietary technology.
Key Person
Herve Villa IFC’s founder and CEO. Ph.D in mechanical engineering. Entrepreneur profile and hand off
owner. Got contracts with Big Three car
companies: GM, Ford, and Chrysler.
Construct production facility in Mexico.
Key Person
John Trudel Former treasurer and CFO. Expert in using financial derivatives. Often, Guest speaker at the Treasury
Management Association of Canada’s regional meetings.
Had free hand in the choice of hedging structure.
Quit IFC in July 1997.
Key Person
Bob Young Present treasury and CFO. Joined IFC in November 1997. Worked at Treasury department for 15
years. Expert in accounting role. However, had no experience in aspect of
new job at IFC.
IFC’s Expansion to Mexico
Financial crisis of Asian Foreign exchange market and equity markets
Spread to other developing countries quickly. Weaken Mexican peso position against to
Canadian Dollars. IFC wants to build the plant in Mexico. Need to get financing from the Manufacture
Bank of New York. Proposed value : 826,000,000 mexican pesos
(MXP).
Basic Issues
Immediate Issues
Cause/Effect diagram
Time Line
Translation Exposure
U.S dollar
Assets Liabilities Net Exposure
62,877,000 300,000,000 237,123,000
Transaction ExposureNet U.S. Dollar Exporsure from Transactions (in US$000s)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec38,654 12,566 6,340 8,587 4,028 (10,726) (150) 9,985 16,714 20,910 24,177 19,636
U.S. Dollar Receipts (in US$000s)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecFord 28,312 9,826 9,114 8,745 6,112 5,348 3,824 8,336 9,878 10,028 14,114 15,750 GM 5,008 6,114 1,838 2,256 1,782 876 742 736 4,924 6,996 7,236 9,338 Chrysler 12,662 5,566 4,962 5,360 3,625 3,478 3,876 9,089 11,112 13,108 12,144 16,727 Honda 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 4,300 Saturn 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700 1,700
Total 51,982 27,506 21,914 22,361 17,519 15,702 14,442 24,161 31,914 36,132 39,494 47,815
U.S. Dollar Payables (in US$000s)
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov DecSalary 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 6,214 9,108 Debt Service - - - - - 12,000 - - - - - 12,000 Materials 7,114 8,726 9,360 7,560 7,277 8,214 8,378 7,962 8,986 9,008 9,103 7,071
Total 13,328 14,940 15,574 13,774 13,491 26,428 14,592 14,176 15,200 15,222 15,317 28,179
Hedging Instruments
Forward contract Plain Vanilla Options Exotic Options
Single Barrier Options Double Barrier Options Average Rate Options Range Binary Options Swing Forward Options
1998Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec AVG
Forward 1.370 1.360 1.380 1.392 1.401 0 0 1.366 1.359 1.351 1.347 1.291 1.362Forecast 1.422 1.420 1.418 1.415 1.415 1.410 1.410 1.410 1.410 1.410 1.410 1.397 1.412Real Rate 1.441 1.433 1.417 1.430 1.445 1.466 1.487 1.535 1.522 1.545 1.540 1.543 1.484Expected Expected Rate Cdn$ 1.3000 per U.S. dollar 1.300
1.338 1.366
1.3001.250
1.300
1.350
1.400
1.450
1.500
1.550 Ja
n 9
6Fe
b 9
6M
ar 9
6A
pr
96
May
96
Jun
96
Jul 9
6A
ug
96
Sep
96
Oct
96
No
v 9
6D
ec
96
Jan
97
Feb
97
Mar
97
Ap
r 9
7M
ay 9
7Ju
n 9
7Ju
l 97
Au
g 9
7Se
p 9
7O
ct 9
7N
ov
97
De
c 9
7Ja
n 9
8Fe
b 9
8M
ar 9
8A
pr
98
May
98
Jun
98
Jul 9
8A
ug
98
Sep
98
Oct
98
No
v 9
8D
ec
98
Historical Foreign Exchange RatesCanadian dollars per on U.S. dollar
Real Rate Forward Forcast Expected
In 1996, Speculators were looking for Cdn$ 1.3000 per
U.S. Dollar and below.
Asian foreign exchange and equity
markets melted down Crisis occurred in the
summer of 1997.
Trudel left the company in July
1997.
“Obviously was looking at the
wrong fundamental”
Source: www.x-rates.com
1.338 1.366
1.410
1.3001.250
1.300
1.350
1.400
1.450
1.500
1.550 Ja
n 9
6Fe
b 9
6M
ar 9
6A
pr
96
May
96
Jun
96
Jul 9
6A
ug
96
Sep
96
Oct
96
No
v 9
6D
ec
96
Jan
97
Feb
97
Mar
97
Ap
r 9
7M
ay 9
7Ju
n 9
7Ju
l 97
Au
g 9
7Se
p 9
7O
ct 9
7N
ov
97
De
c 9
7Ja
n 9
8Fe
b 9
8M
ar 9
8A
pr
98
May
98
Jun
98
Jul 9
8A
ug
98
Sep
98
Oct
98
No
v 9
8D
ec
98
Historical Foreign Exchange RatesCanadian dollars per on U.S. dollar
Real Rate Forward Forcast Expected
1998Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec AVG
Forward 1.370 1.360 1.380 1.392 1.401 0 0 1.366 1.359 1.351 1.347 1.291 1.362Forecast 1.422 1.420 1.418 1.415 1.415 1.410 1.410 1.410 1.410 1.410 1.410 1.397 1.412Real Rate 1.441 1.433 1.417 1.430 1.445 1.466 1.487 1.535 1.522 1.545 1.540 1.543 1.484Expected Expected Rate Cdn$ 1.3000 per U.S. dollar 1.300
Source: www.x-rates.com
1.338
1.535
1.366
1.410
1.3001.250
1.300
1.350
1.400
1.450
1.500
1.550 Ja
n 9
6Fe
b 9
6M
ar 9
6A
pr
96
May
96
Jun
96
Jul 9
6A
ug
96
Sep
96
Oct
96
No
v 9
6D
ec
96
Jan
97
Feb
97
Mar
97
Ap
r 9
7M
ay 9
7Ju
n 9
7Ju
l 97
Au
g 9
7Se
p 9
7O
ct 9
7N
ov
97
De
c 9
7Ja
n 9
8Fe
b 9
8M
ar 9
8A
pr
98
May
98
Jun
98
Jul 9
8A
ug
98
Sep
98
Oct
98
No
v 9
8D
ec
98
Historical Foreign Exchange RatesCanadian dollars per on U.S. dollar
Real Rate Forward Forcast Expected
1998Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec AVG
Forward 1.370 1.360 1.380 1.392 1.401 0 0 1.366 1.359 1.351 1.347 1.291 1.362Forecast 1.422 1.420 1.418 1.415 1.415 1.410 1.410 1.410 1.410 1.410 1.410 1.397 1.412Real Rate 1.441 1.433 1.417 1.430 1.445 1.466 1.487 1.535 1.522 1.545 1.540 1.543 1.484Expected Expected Rate Cdn$ 1.3000 per U.S. dollar 1.300
Source: www.x-rates.com
Forward Contract
57.7% Over Hedge in March Total 12.0% Over Hedge
1998 Net Exposure Forward Over Hedge Under Hedge % Over Hedge
Jan 38.66 45.00 6.34 16.4%Feb 12.57 15.00 2.43 19.3%Mar 6.34 10.00 3.66 57.7%Apr 8.59 10.00 1.41 16.4%May 4.03 5.00 0.97 24.1%JunJulAug 10.01 10.00Sep 16.72 15.00 -1.72Oct 20.91 25.00 4.09 19.6%Nov 24.18 25.00 0.82 3.4%Dec 19.64 5.00 -14.64
Total 161.65 165.00 19.72 -16.36 12.0%
1998 Forward Forecast Real Rate 1998 Net Exposure Forward Over Hedge Under Hedge % Over Hedge
Jan 1.370 1.422 1.441 Jan 38.66 45.00 6.34 16.4%Feb 1.360 1.420 1.433 Feb 12.57 15.00 2.43 19.3%Mar 1.380 1.418 1.417 Mar 6.34 10.00 3.66 57.7%Apr 1.392 1.415 1.430 Apr 8.59 10.00 1.41 16.4%May 1.401 1.415 1.445 May 4.03 5.00 0.97 24.1%Jun 1.410 1.466 JunJul 1.410 1.487 JulAug 1.366 1.410 1.535 Aug 10.01 10.00Sep 1.359 1.410 1.522 Sep 16.72 15.00 -1.72Oct 1.351 1.410 1.545 Oct 20.91 25.00 4.09 19.6%Nov 1.347 1.410 1.540 Nov 24.18 25.00 0.82 3.4%Dec 1.291 1.397 1.543 Dec 19.64 5.00 -14.64
AVG 1.362 1.412 1.484 Total 161.65 165.00 19.72 -16.36 12.0%
Forward Contract Possible Profits/Losses
Forecast Rates Real Rates Expected Rate Cdn$ 1.3000 per U.S. dollar
1998 Net Exposure Over Hedge Under Hedge Total Net Exposure Over Hedge Under Hedge Total Net Exposure Over Hedge Under Hedge Total
Jan -2.00 -0.33 -2.33 -2.74 -0.45 -3.19 2.71 0.44 3.15Feb -0.75 -0.14 -0.89 -0.92 -0.18 -1.10 0.76 0.15 0.90Mar -0.24 -0.14 -0.38 -0.23 -0.13 -0.37 0.51 0.29 0.80Apr -0.21 -0.03 -0.24 -0.33 -0.05 -0.38 0.79 0.13 0.91May -0.06 -0.01 -0.07 -0.18 -0.04 -0.22 0.41 0.10 0.50Jun
Jul
Aug -0.44 -0.43 -1.69 -1.68 0.66 0.66Sep -0.85 0.09 -0.76 -2.72 0.28 -2.44 0.98 -0.10 0.88Oct -1.22 -0.24 -1.46 -4.05 -0.79 -4.85 1.07 0.21 1.28Nov -1.52 -0.05 -1.57 -4.67 -0.16 -4.83 1.14 0.04 1.18Dec -2.09 1.56 -0.53 -4.96 3.70 -1.26 -0.18 0.14 -0.05
Total -9.37 -0.95 1.65 -8.67 -22.50 -1.81 3.98 -20.33 8.84 1.36 0.04 10.23
Plain Vanilla Option
IFC’s transaction exposure is long position.
IFC purchased Canada Call. Gave them the right to sell U.S dollar
and buy Canadian dollars at the strike price 1.40.
1998 Vanilla Option Forecast Real Rate 1998 Net Exposure Vanilla Option
Jan 1.422 1.441 Jan 38.66Feb 1.420 1.433 Feb 12.57Mar 1.418 1.417 Mar 6.34Apr 1.415 1.430 Apr 8.59May 1.415 1.445 May 4.03Jun 1.410 1.466 Jun -10.73Jul 1.410 1.487 Jul -0.15Aug 1.400 1.410 1.535 Aug 10.01 5.00Sep 1.400 1.410 1.522 Sep 16.72 5.00Oct 1.410 1.545 Oct 20.91Nov 1.410 1.540 Nov 24.18Dec 1.400 1.397 1.543 Dec 19.64 15.00
AVG 1.400 1.412 1.484 Total 150.77 25.00
Vanilla Option Possible Profits/Losses
1998 Forecast Rates Real Rates Expected Rate Cdn$ 1.3000 per U.S. dollarJan
Feb
Mar
Apr
May
Jun
Jul
Aug -0.05 -0.62 0.55Sep -0.05 -0.56 0.55Oct
Nov
Dec 0.04 -2.19 1.46
Total -0.06 -3.38 2.56
Range Binary
A double barrier binary option with knock-in and knock-out triggers.
Binary option in which the payout is all or nothing. IFC would get $10 million if and only if
neither foreign exchange rates of 1.3750 nor 1.4750 trade before the end of March 1998.
Premium: US $ 1.47 million. Fact: Neither rates did trade. Result: IFC got US$ 10 million.
Swing Forward
Zero cost at inception. Combination of buying a call and selling
a put or buying a put and selling a call at the same strike price.
Contains single barrier knock-in written option.
IFC’s Portfolio
Possible Profits/Losses (in U.S.$ Million )
Forecast Rates Real Rates Expected Rate Cdn$ 1.3000 per U.S. dollar
Forward Contract -8.67 -20.33 +10.23
Vanilla Option - - +2.56
Range Binary +10.00 +10.00 -
Swing Forward - - -
Total +1.33 -10.33 +12.79
Evaluation
Over-hedge translation exposure. Exotic options seem to be speculation. Lack of internal controls. Lack of financial risk measurement
program such as Value at risk (VaR). Lack of efficient computer system. Similar to a hedge fund trading portfolio
more than a corporate’s hedging schedule.
Recommendation
Implement Value-at-Risk measurement. Invest in advanced computer systems. Do not over-hedging. Predictable event, use forward contract. Unpredictable event, use option. Combine hedging strategy.
Recommendation
Develop clear risk management policy. Specify a detailed risk management
philosophy with procedures and controls. Use of derivatives should consistent with
overall risk management and capital policy approved by board of directors and senior management.
Risk limit policies and monitor of transactions.
Disclose information about their use of derivatives.
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