Download Measuring Market Exposure - NYU Stern School of Business

Treasury 2000
NYU/GTA
Managing Financial Risk:
Case Study
Prof. Ian Giddy
New York University
The Exposure Triangle
Transactions
Exposure
Translation
Exposure
Copyright ©1999 Ian H. Giddy
Economic
Exposure
Financial Risk Management: Case Study -2
Case Study: Photronics
PHOTOMASKS
US DOLLARS
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -3
Case Study: Photronics
Photronics is the world's leading and fastest
growing manufacturer of photomasks.
Photomasks are high precision quartz plates that
contain microscopic images of electronic
circuits. A key element and enabling technology
in the manufacture of semiconductors,
photomasks are used to transfer circuit patterns
onto semiconductor wafers during the fabrication
of integrated circuits. They are produced in
accordance with circuit designs provided by
customers at strategically located manufacturing
facilities in North America, Europe and Asia.
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -4
Photronics’ International Business
“Photronics has made excellent progress in expanding its presence
around the world both by acquisitions and by the construction of new
facilities. During the year, new facilities were quickly brought to full
production in Manchester, England, and Austin, Texas, while additional
technological capability was installed in Singapore. These advanced
capabilities have elevated our strategic supplier status with many
significant customers who are now benefiting from our balanced
approach to international expansion and technology investments.
“ In Asia, our Singapore facility is benefiting from our customers'
utilization of wafer foundries, reflecting the increasing trend of
semiconductor manufacturers moving toward a fabless business
model. We believe that the number of companies utilizing foundries will
increase as they focus on their core strengths—designing
semiconductors and product marketing. Such a business model
transfers the risk associated with investing capital in production assets,
giving the now "fabless" semiconductor company additional flexibility
during down cycles, like the one affecting the semiconductor industry today.”
Copyright ©1999 Ian H. Giddy
From 1998 Annual Report
”The globalization of the semiconductor industry has created significant
growth opportunities beyond Photronics' core market in North America.
Customers operating manufacturing facilities in Asia and Europe, as
well as North America, are streamlining their equipment and materials
procurement processes, relying on fewer and more capable suppliers.
Financial Risk Management: Case Study -5
Case Study: Photronics
The company and its currency exposure
 Income, cash flow and translation
effects
 The economic risks

Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -6
Photronics’ International Acquisitions
?
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Financial Risk Management: Case Study -7
Sales and Asset Abroad
?
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -8
The Company’s Debt
?
Copyright ©1999 Ian H. Giddy
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Photronics: Translation Exposure
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -10
Translation Policy
The Company's subsidiaries in Europe and Singapore maintain their accounts in their
respective local currencies. Assets and liabilities of such subsidiaries are translated to
U.S. dollars at year-end exchange rates. Income and expenses are translated at average
rates of exchange prevailing during the year. Foreign currency translation adjustments
are accumulated in a separate component of shareholders' equity. The effects of changes
in exchange rates on foreign currency transactions are included in income.
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -11
Exposed or Not Exposed?
Balance Sheet
Item
1. Fixed Assets
Exchange Net
Prices Rates
Effect
2. Inventories
3. Monetary Items
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -12
Photronics: Cash Flow Exposure
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -14
Currency Risk: Economic Exposure
Change in the economic value of the firm
resulting from unanticipated exchange
rate changes.
 Booked vs. anticipated transactions
 Expected vs. unexpected changes; the
"cost of hedging"
 Exposure and the parity assumptions:
"We are not exposed in the long run"
 Currency of denomination vs currency of
determination; compet., elasticities, etc.
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -15
Economic Exposure

Economic exposure is how the firm’s
revenues and costs will respond to
exchange rate changes.
 Example:
Even though Intel invoices German
customers in marks, its future revenues may be
unaffected by fluctuations in the mark if the currency
of determination of prices in the semiconductor
business is the dollar or even the yen.

The currency of determination is the
currency in which most of the competition
prices similar products.
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -16
Operational Aspects of Exchange Risk
1.VOLUME EFFECTS (compensate for
changes in profit margins)
2.PRICING FLEXIBILITY (change in
margins to offset effect of exchange rate
change)
3.DIVERSIFICATION of markets for
inputs and outputs
4.FLEXIBILITY (ability to shift markets
and sources quickly)
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -17
Translation vs Economic Exposure
Accounting exposure
 Exposure = "Exposed" assets - "exposed"
liabilities
Economic exposure
 Exposure = How will an unanticipated exchange
rate change affect the cash flows of the firm?
 Domestic
sales
 Exports
 Domestic
costs
 Import costs
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -18
A Realistic Approach



Banks versus corporations: To the extent that the
firm is like a bank, do bank-style hedging. Match
financial assets with liabilities of the same kind.
Seek to identify economic exposure using
product cost-and-market analysis, industry
competitive analysis, or statistical analysis on the
sensitivity of the company’s value to exchange
rate changes.
Hedge economic exposure using debt/swaps for
long term exposure, short term instruments for
uncertain exposure, and options for disaster
insurance
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -19
Photronics: Economic Exposure
SOLD IN UK
INVOICED IN GBP



A/R
INVENTORY
PLANT
Copyright ©1999 Ian H. Giddy
GBP?
PHOTOMASKS
Financial Risk Management: Case Study -20
Photronics: Economic Exposure



A/R
INVENTORY
PLANT
Copyright ©1999 Ian H. Giddy
PHOTOMASKS
SOLD IN UK
INVOICED IN GBP
GBP?
SOLD IN
WORLDWIDE MARKET
USD?
Financial Risk Management: Case Study -21
Photronics: Economic Exposure



A/R
INVENTORY
PLANT
Copyright ©1999 Ian H. Giddy
PHOTOMASKS
SOLD IN UK
INVOICED IN GBP
GBP?
SOLD IN
WORLDWIDE MARKET
USD?
DETERMINED BY
COMPETITION
JPY?
Financial Risk Management: Case Study -22
Summary: Types of Exposure
Transactions
Exposure
Translation
Exposure
Copyright ©1999 Ian H. Giddy
Economic
Exposure
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What Should Photronics Do?




Hedge, or suffer translation gains & losses?
How can its exposure be gauged?
What does FAS 133 imply for a company like
this?
What tools should be used?
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -24
Which Instrument?
Identifiable
Debt, swaps,
exposure
forward contracts
Uncertain exposure Instruments with
flexibility, such as
forwards and futures
Exposure that
Deep-out-of-thethreatens financial money options
distress
Copyright ©1999 Ian H. Giddy
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A Corporate Foreign Exchange
Roadmap
UNDERSTANDING THE EXCHANGE
RISK MANAGEMENT PROBLEM
 Value of hedging
 Goals
 Nature of the business
MEASUREMENT OF EXPOSURE
ACCOUNTING
Examples:

Sourcing flexibility

Pricing strategy

Market
diversification
Copyright ©1999 Ian H. Giddy
ECONOMIC
NATURE OF THE CASH FLOW EXPOSURE:
 One-shot?
 Linear?
 Contingent on exchange rates?
 Contingent on other events?
HEDGING METHODS
OPERATIONAL
TRANSACTION
FINANCIAL
Linear

Forwards

Futures

Debt

Currency swaps
Exchange-rate
contingent

Options

Debt with option
features
Contingent on
other events

Event options

Probability-based
hedging
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Ian Giddy
Ian H. Giddy
NYU Stern School of Business
44 West 4th Street, New York, NY 10012
Tel 212-998-0332; Fax 212-995-4233
[email protected]
http://www.giddy.org
Copyright ©1999 Ian H. Giddy
Financial Risk Management: Case Study -30