FiREapps Currency 101

Foreign Exchange Hedging Tutorial:Currency Impacts 101

Foreign Exchange Impacts on Corporate ValueMerrill Lynch Analyst & Investor Presentation

Presented by FiREappsOctober 31, 2008

This presentation is copyright 2008 Rim Tec Inc., all rights reserved. Any unauthorized reproduction or distribution is prohibited. Any authorized reproduction or distribution of this presentation must include this copyright notice and shall not remove or alter any references to Rim Tec or the FiREapps Service or other Rim Tec products or services contained herein.

Copyright 2008 Rim Tec Inc. Slide 2

Speaker Introductions

Wolfgang Koester, CEO, FiREapps• Managed risk for a Fortune 500 companies &

governments, including G-10s, since 1986

• Monthly contributor to AFP Exchange magazine & member of AFP Risk editorial board

• One of Treasury and Risk magazine’s 2008 “100 Most Influential People in Finance”

• Member Global Exchange 2007 “Who’s Who in Foreign Exchange”

• Contributor to Treasury and Risk, Corporate Board Member, Business Finance, eForex and GT News

• CFO, Fortune, Wall Street Journal and the Economist


Index: Currency Impacts on Corporations

Impact

Exposure

Net Risk

Actions

Risk

Solution

2.Income Statement, Balance Sheet

3.Operational & Financial (hedging)

4. What you should ask as an investor / analysts / board member

1.Introduction


Discussion Overview


• “There is No Free Pass for Foreign Exchange”– Treasurer, Microsoft

• Pharmaceutical Company FX Impacts10Q – Johnson & Johnson – Released 8/4/2008

• Located in ‘Item 2 – Management’s Discussion & Analysis• “For the first fiscal six months of 2008, worldwide sales were $32.6 billion, a total

increase of 8.2% including an operational increase of 2.8% over 2007 first fiscal six months sales of $30.2 billion. Currency had a positive impact of 5.4% for the period.”

10K – Bristol Myers Squibb – Released 2/22/2008• Located in ‘Results of Operations’• Net sales from continuing operations for 2007 increased 12% to $19.3 billion,

including a 3% favorable foreign exchange impact, compared to 2006. U.S. net sales in 2007 increased 18% to $10.8 billion compared to 2006. International net sales in 2007 increased 5% to $8.5 billion compared to 2006, including a 7% favorable foreign exchange impact.

• Solution– FA Client Quote: “We have no FX Surprises”

A Perfect Storm


Business Units

Corporate Controllers

The Beginning of the Problem

Several days

Banks and Trading PlatformsComplex Exposure

Reporting Spreadsheets

Controller Treasurer

1. Accounting

2. Actions


Translate Your Financial Statements into Reporting Currency


Currency Definitions

• Local– The currency of the country of domicile

• Functional– The currency of the primary economic environment in

which the entity operates; normally the currency in which an entity generates and expends cash

– FAS 52 introduced the concept of functional currency

• Transaction– The currency in a business transaction has been

executed

• Reporting– The currency in which an enterprise prepares its financial

statementsCopyright 2008 Rim Tec Inc. Slide 9

FASB Statement No.52

• Foreign Currency Translation

• Affects the financial reporting of companies operating in foreign countries

• Provided information that is compatible with the expected economic effects of a rate change on an enterprise’s cash flows and equity – Adjustments for impacts that do not effect cash flow are

excluded from net income


FASB Statement No.133

• Accounting for Derivative Instruments & Hedging Activities

• A hedge of a forecasted event is a ‘cash flow hedge’

• The results from cash flow hedges must be evaluated – The ineffective part goes to the Income Statement– The effective part is posted to Other Comprehensive

Income (OCI) in the Balance Sheet

• Amounts in OCI are reclassified to the Income Statement when the forecasted cash flow affects earnings


R= E x v

Exposure x Volatility

Risk =

$100,000 =

$1,000,000

x 10%


Exposurex Volatility

Risk =

September 2008 Exposure Volatility Risk (One Week)

G10 Currencies $70MM 10% = $7M

Non-G10 Currencies

$30MM 25% = $7.5M

$100,000 =

$,1000,000

x 10%

CompleteUnderstanding


R= E x v

Exposure x Volatility

Risk =

September 2008 Exposure Volatility Risk (One Week)

G10 Currencies $70MM 10% = $7M

Non-G10 Currencies

$30MM 25% = $7.5M

$100,000 =

$1,000,000

x 10%

September 2008 Exposure Volatility Risk (One Day)

G10 Currencies $70MM 1% = $0.7M

Non-G10 Currencies

$30MM 3.2% = $0.96M

CompleteUnderstanding

Time


R= E x v

Index: ExposureIncome Statement & Balance Sheet

Impact

Exposure Risk


1. Introduction


FX Impacts to the Income Statement

Revenue

Costs (COGS + Opex)

Net Operating Income

Other Income/expenses

FX Gain/Loss

Net Income

Shares Outstanding

EPS

Income StatementForeign currency-denominated revenues & costs are translated to USD each reporting period

• Fluctuating exchange rates affects reported revenues and costs

FX gain/loss results from Balance Sheet transactions

• Realized from clearing foreign currency denominated monetary assets & liabilities

• Unrealized from FAS 52 remeasurement of monetary assets & liabilities at month end


Companies doing business in foreign currencies risk NOI, Net Income & EPS impact

FX Impacts to the Balance Sheet

Assets

Liabilities

Stockholder’s Equity

Domestic Balance Sheet

• FX can significantly affect asset-liability balances when translated

• Some of translation does not flow through the income statement (i.e. equipment)

• Recorded as cumulative translation adjustment (CTA) in Other Comprehensive Income (OCI)

• CTA taken into account when a disposition occursCopyright 2008 Rim Tec Inc. Slide 17

International Balance SheetAssets

Liabilities

Stockholder’s Equity

OCI (CTA) “The Plug”

Accounting Impacts & FAS 52

Transaction Currency

Functional Currency

Reporting Currency

Result

Example 1 Revenue EUR EUR USD USD value of EUR revenue at risk

translation


Example 2 Revenue EUR USD USD USD Value of EUR revenue at risk

translation

Example 3 A/R EUR EUR USD No income statement effect; only CTA adjustment in Balance Sheet

No fx gain/loss from remeasurement

Translation gain/loss (CTA)

Example 4 A/R EUR USD USD Income statement effect from FAS 52 remeasurement; no CTA adjustment

fx gain/loss from remeasurement

No translation gain/loss (CTA)

Impacts of a Rising Dollar

Q3 Guidance EUR USD Rate=1.55

Example: EUR Revenue Financial Statement RiskNotes


August Sale120 day payment terms

Aug EUR Rate=1.50 Revenue EUR Revenue translated at August average rate

August Month-end

Balance Sheet Rate=1.45

FX gain/loss Account Receivable Remeasurement

SeptemberMonth-end


FX gain/loss Account Receivable Remeasurement

December 27Month-end

Balance Sheet rate=1.28

FX gain/loss A/R Collected, Converted to USD

Result: $.27 (17%) difference between projected revenue & cash collection

Index: ActionsOperational & Financial

Impact

Exposure

Actions

Risk2.Income

Statement, Balance Sheet

3. Operational & Financial (hedging)


How Do You Get Your House in Order?

a) Understand your exposureb) Take action - operational



c) Take Action - Hedge


Income Statement Hedging• Protecting the USD value of non-USD

revenue & costs–Cash flow hedging; focused on top-line & NOI

• Typical time horizon: 6 months to 3 years

• FASS 133 for hedge accounting treatment–want to match hedge results to when the forecasted transactions occur

• Effective hedges are recorded & held in OCI (Balance Sheet) until the forecasted transactions occur; ineffectiveness flows immediately to the income statement


Transaction Currency/Functional Currency and Impact on Cash Flow Hedging

Hedging Relationship

Risk Transaction Currency

Functional Currency

Reporting Currency

Cash Flow Hedge?


Example 1 Revenue EUR USD USD Can hedge EUR-USD risk

Example 2 Revenue EUR EUR USD Cannot hedge EUR-USD risk

Example 3 Revenue EUR GBP USD Cannot hedge EUR-USD risk


Balance Sheet Hedging• Reducing the volatility of the FX

gain/loss line in the income statement – part of managing Net Income/EPS risk

• FX gain/loss results from:– Clearing recorded monetary assets/liabilities

on the balance sheet (realized)– Remeasurement of monetary assets/liabilities

at period end (unrealized)

• Hedge results are recognized currently in the income statement

• Overhedging typically occurs due to a lack of complete & timely understanding of exposures


Assets

Liabilities

OE

OCI (CTA)

Impacts of a Rising Dollar

Q3 Guidance EUR USD Rate=1.55 Cash Flow Hedge – FAS133 Hedge accounting

Example: EUR Revenue Financial Statement RiskHedge Actions


August Sale120 day payment terms

Aug EUR Rate=1.50 Revenue Cash Flow Hedge ExpiresBalance sheet hedge of A/R – 120+ days

August Month-end


FX gain/loss Balance sheet hedgeContinues

SeptemberMonth-end


FX gain/loss Balance Sheet HedgeContinues

December 27Collection

Balance Sheet rate=1.28

FX gain/loss Close Balance Sheet Hedge when Cash is Converted

Result: Reduced currency impacts on your corporation


Index: Currency Impacts on Corporations

Impact

Exposure

Net Risk

Actions

Risk

Solution


3. Operational & Financial (hedging)

4. What you should ask as an investor / analysts / board member

1. Introduction

Recommendations

What Should You an Analyst / Investor / Constituent Do With All This?


Recommendations

• Understand that FX exposure management is complex & difficult

• Drive for succinct answers to four questions• What are your exposures-past, present & forecasted?

– Income statement [impact on NOI, NI & EPS)– Balance sheet [impact on OCI (CTA)]

• What actions are you taking to protect corporate value?• What net risk are you managing towards (exposure x volatility)?• What was your actual risk?

• For historic purposes, examine earnings releases, 10K (incl. Item 7a) & 10Q (incl. Item 3)


Example

Exposure

Net Risk

Actions

RiskBalance Sheet Exposure = $1.2B

Actions: <$800M>

$400M x 10% (Vol) =

$40M Net Risk


FiREapps Solution


Aggregate FX data for Balance Sheets & Cash Flows at the Push of a Button

• Creates transparency & understanding (completeness)• Can act within hours (not weeks, or months)

Result–No Surprises–Volatility ↓–Cost ↓–Less hedges

–Improve Communications–Enable Compliance –Improve Operational Efficiency

–Less time on aggregation–More value add

Thank You

For More Information

• View this presentation online at www.fireapps.com/news/presentation.html

• Contact FiREapps– Email: [email protected]– Phone: 480-443-7333 x157

• Visit our Web site at www.fireapps.com– Attend live and recorded Webinars– Download whitepapers– Read related trade and business articles


http://www.fireapps.com/news/presentation.html

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FiREapps Currency 101

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