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Gray, Salter & RadebaughChapter 2
GLOBAL ACCOUNTING AND CONTROL: AGLOBAL ACCOUNTING AND CONTROL: A
MANAGERIAL EMPHASISMANAGERIAL EMPHASIS
a Sidney J. GraySidney J. Gray, University of New South, University of New South
WalesWales
a Stephen B. SalterStephen B. Salter, University of Cincinnati, University of Cincinnati
a Lee H. RadebaughLee H. Radebaugh, Brigham Young, Brigham Young
UniversityUniversity
a Slides Prepared by: Jennifer Anne SalterSlides Prepared by: Jennifer Anne Salter
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Gray, Salter & RadebaughChapter 2
INTRODUCTIONINTRODUCTION
a This chapter explains:This chapter explains:
terminology of foreign exchange;terminology of foreign exchange;
major foreign exchange products;major foreign exchange products;
major types of foreign exchange risks;major types of foreign exchange risks;
alternative approaches to foreign exchangealternative approaches to foreign exchange
risk management.risk management.
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Gray, Salter & RadebaughChapter 2
FX RISKS & SOLUTIONS CONTDFX RISKS & SOLUTIONS CONTD- An Import for Cash Problem- An Import for Cash Problem
Firm Location Currency Amt
Suntech California,
USA
US$ $107
ChangiBoards
Singapore Sin. $ $170
McBoards Edinburgh,
UK
British 64
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Gray, Salter & RadebaughChapter 2
FX RISKS & SOLUTIONS CONTDFX RISKS & SOLUTIONS CONTD
- An Import for Cash Problem- An Import for Cash Problem
a What do we do now?What do we do now? Calculate the price in a common currency (US$Calculate the price in a common currency (US$
would be logical since you are US based).would be logical since you are US based).a How do we do that?How do we do that?
Get the price in local currency (Get the price in local currency (LCPLCP) for each) for eachlocation from the table.location from the table.
Divide theDivide the LCPLCP by the LC/US$ exchange rate toby the LC/US$ exchange rate toget theget the US$US$ Price. See Table 2.1/2.2 orPrice. See Table 2.1/2.2 orhttp://www.http://www.bmobmo.com/economic/.com/economic/..
http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/http://www.bmo.com/economic/8/14/2019 Chapter 2 Power Point Slides
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Gray, Salter & RadebaughChapter 2
Lets look at 2.1 FirstLets look at 2.1 First
a its a word fileits a word file
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Gray, Salter & RadebaughChapter 2
FX RISKS & SOLUTIONS CONTDFX RISKS & SOLUTIONS CONTD
- An Import for Cash Problem- An Import for Cash Problem
Company Country LocalCurrency
Price
# ofForeign
CurrencyUnits per
US$
US$Price
Suntech USA $105 1 $105
Changi
Boards
Singapore Sin$170 1.6783 $101.29
McBoards U.K. 64 0.6054 $105.71
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Gray, Salter & RadebaughChapter 2
Lets change the number toLets change the number to
Today's rates fromToday's rates from BMOBMO
US $
Price
A/BSuntec
h
USA $105 1.0000 $105.00
Changi
Boards
Sing
apo
re
SGD 170.00 $0.55 $92.65
Mcboar
ds
Briti
sh
Pou
nds
64.00 $1.41 $90.39
Compa
ny
Cou
ntry
Local
Currency
price (A)
Number of Units
Per $Foreign
Currency (B)
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Gray, Salter & RadebaughChapter 2
FOREIGN EXCHANGE RISKS ANDFOREIGN EXCHANGE RISKS AND
SOLUTIONS -SOLUTIONS - Import for CreditImport for Credit
a What if you want to buy on credit?What if you want to buy on credit?
a Is Singapore still the cheapest supplier?Is Singapore still the cheapest supplier?
a Will the exchange rate stay the same?Will the exchange rate stay the same?
a Can you protect yourself from fluctuationsCan you protect yourself from fluctuations
in the exchange rate?in the exchange rate?
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Gray, Salter & RadebaughChapter 2
FOREIGN EXCHANGE RISKS ANDFOREIGN EXCHANGE RISKS AND
SOLUTIONS -SOLUTIONS - Import for Credit ProblemImport for Credit Problem
a McBoards offers 6McBoards offers 6
mos. interest freemos. interest free
credit.credit.a For the others youFor the others you
must borrow at 1% permust borrow at 1% per
month.month.
a However, the BritishHowever, the British
Pound is a floatingPound is a floating
currency.currency.
DATE
GBP/
US$
Jan-99 $0.61
Feb-99 $0.61Mar-99 $0.62 Apr-99 $0.62May-99 $0.62
Jun-99 $0.63Jul-99 $0.63
Aug-99 $0.62Sep-99 $0.62
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Gray, Salter & RadebaughChapter 2
The British Pound FloatsThe British Pound Floats
1.5
1.55
1.6
1.65
1.7
Jan-
99
Feb-
99
Mar-
99
Apr-
99
May-
99
Jun-
99
Jul-
99
A
ug-
99
Sep-
99
Month
US$/G
Number of $ per GBP
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Gray, Salter & RadebaughChapter 2
FOREIGN EXCHANGE RISKS ANDFOREIGN EXCHANGE RISKS AND
SOLUTIONS -SOLUTIONS - Import for Credit ProblemImport for Credit Problem
a You can neutralize theYou can neutralize the
risk of the British risk of the British
changing in value bychanging in value byusing a derivative.using a derivative.
a FX Derivatives canFX Derivatives can
include forwardinclude forward
contracts, futures,contracts, futures,swaps and options.swaps and options.
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Gray, Salter & RadebaughChapter 2
Derivatives - Forward ContractsDerivatives - Forward Contracts
a AAForward ContractForward Contract is a contract between ais a contract between a
foreign currency trader and a client for theforeign currency trader and a client for the
future sale or purchase of foreign currencyfuture sale or purchase of foreign currencyat a forward rate.at a forward rate.
a TheThe Forward RateForward Rate is a contractual rateis a contractual rate
between the FX trader/client for thebetween the FX trader/client for theamount of currency A needed to acquireamount of currency A needed to acquire
one unit of currency B at a fixed futureone unit of currency B at a fixed future
date. (Tbl 2.1)date. (Tbl 2.1)
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Gray, Salter & RadebaughChapter 2
Derivatives - Forward ContractsDerivatives - Forward Contracts
Extract from Table 2.1Extract from Table 2.1
a British Pound Per DollarBritish Pound Per Dollar
a SpotSpot .6054.6054
a One Month ForwardOne Month Forward .6054.6054
a Three Months ForwardThree Months Forward .6051.6051
a
Six Months ForwardSix Months Forward .6053.6053
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Gray, Salter & RadebaughChapter 2
Derivatives - Forward ContractsDerivatives - Forward Contracts
a Table 2.3 shows the impact of applying theTable 2.3 shows the impact of applying the
information on forward and interest ratesinformation on forward and interest rates
to the purchase of boards.to the purchase of boards.a The Singapore $ rate assumes that youThe Singapore $ rate assumes that you
have to pay cash spot for the purchasehave to pay cash spot for the purchase
from Singapore.from Singapore.
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Gray, Salter & RadebaughChapter 2
Derivatives - Forward ContractsDerivatives - Forward Contracts
Co. LCP(A)
LCUnitsPer $(B)
US $PriceA/B
Cost of100 units
Interest for6 months
TotalCost
Suntech $105 1.00 105.00 $10,500 $630 $11,130ChangiBoards
170 1.68 101.29 $10,129 $607.7 $10,736
McBoards 64 0.61 105.73 $10,573 $0 $10,573
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Gray, Salter & RadebaughChapter 2
Derivatives - Forward ContractsDerivatives - Forward Contracts
a From the pervious table we can conclude:From the pervious table we can conclude: McBoards initial US$ price is higher than otherMcBoards initial US$ price is higher than other
suppliers;suppliers; A deferred payment option with a forwardA deferred payment option with a forward
contract makes the British product a great dealcontract makes the British product a great dealmore attractive.more attractive. Lets redo this for todays rateLets redo this for todays rate
inin $/FC$/FCa Now lets talk about other methods ofNow lets talk about other methods of
containing FX risks.containing FX risks.
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Gray, Salter & RadebaughChapter 2
At Today's RatesAt Today's Rates
Co. LCP (A) LC Units
Per $ (B)
US $ Price
A*B
Cost of
100 units
Interest for
6 months
Total Cost
Suntech $105 1 105 $10,500 $630 $11,130
Changi
Boards
SGD 170 0.545 92.65 $10,129 $607.70 $10,736
McBoards 64 1.4018 89.7152 $10,573 $0 $10,573
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Gray, Salter & RadebaughChapter 2
Derivatives - Futures, Swaps andDerivatives - Futures, Swaps and
OptionsOptions
a AAFutureFuture is a highly standardized foreignis a highly standardized foreign
exchange contract written against theexchange contract written against the
exchange clearing house for a fixedexchange clearing house for a fixednumber of foreign currency units and fornumber of foreign currency units and for
delivery on a fixed day.delivery on a fixed day.
a AASwapSwap is a simultaneous spot and forwardis a simultaneous spot and forwardtransaction.transaction.
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Gray, Salter & RadebaughChapter 2
Derivatives - Futures, Swaps andDerivatives - Futures, Swaps and
Options ContinuedOptions Continued
a AnAn OptionOption is the right to trade foreignis the right to trade foreign
currency at a given exchange rate on orcurrency at a given exchange rate on or
before a given date in the future.before a given date in the future.a There are two types of options:There are two types of options:
American Options - exercised during aAmerican Options - exercised during a
stipulated period.stipulated period. European Options - exercised at a specifiedEuropean Options - exercised at a specified
end date.end date.
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Gray, Salter & RadebaughChapter 2
Derivatives - Futures, Swaps andDerivatives - Futures, Swaps and
Options ContinuedOptions Continued
a OptionsOptions have the following terms:have the following terms:
An up front fee for the right to buy or sell a fixedAn up front fee for the right to buy or sell a fixed
amount of foreign currency.amount of foreign currency. This is given in US cents per foreign currencyThis is given in US cents per foreign currency
unit.unit.
This is in addition to the actual cost of theThis is in addition to the actual cost of theforeign currency.foreign currency.
Tables 2.4-2.6 in your text contain an exampleTables 2.4-2.6 in your text contain an example
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Gray, Salter & RadebaughChapter 2
Major World Currency MarketsMajor World Currency Markets
a Markets cover almost 24 hours, starting withMarkets cover almost 24 hours, starting with
Auckland which is 14-16 hours ahead of Ohio, ie., ifAuckland which is 14-16 hours ahead of Ohio, ie., if
its 4pm in Cincinnati, its 11am the next day inits 4pm in Cincinnati, its 11am the next day inAuckland.Auckland.
a Tokyo: Cincinnati + 13 hours. About 15% of totalTokyo: Cincinnati + 13 hours. About 15% of total
volumevolume
a Hong Kong & Singapore: Cincinnati + 11 and 12Hong Kong & Singapore: Cincinnati + 11 and 12
hours respectively. Together roughly equal tohours respectively. Together roughly equal to
Tokyo in volume.Tokyo in volume.
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Gray, Salter & RadebaughChapter 2
Continued:Continued:
a European Markets: London is the largestEuropean Markets: London is the largestmarket. Cincinnati + 5 hours. About 25% ofmarket. Cincinnati + 5 hours. About 25% of
total world market volumetotal world market volumea Other markets include Frankfurt and ZurichOther markets include Frankfurt and Zuricha North American Markets: New York is theNorth American Markets: New York is the
second largest market. Other marketssecond largest market. Other marketsinclude Chicago, San Francisco andinclude Chicago, San Francisco andToronto.Toronto.
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Gray, Salter & RadebaughChapter 2
Continued:Continued:
a NOTE: Over 90% of all transactions includeNOTE: Over 90% of all transactions include
the US$ as one part, e.g., DM/$, etc.the US$ as one part, e.g., DM/$, etc.
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Gray, Salter & RadebaughChapter 2
-- Selling at a Premium orSelling at a Premium or
DiscountDiscount
a Appli es to For war ds /Future sppli es to For war ds /Future sa PREMIUMREMIUM -- IF th e q u ota ti o n o f th e c urr enc yF th e q u ota ti o n o f th e c urr enc y
in the denomi na torn the denomi na tor ,, e. g., i n a $/ i s. g., i n a $/ i sgr ea ter f or del i ve ry i n th e f utu r er ea ter f or del i ve ry i n th e f utu r e(fo rw ar d) tha n f or del ive ry n ow (s pot),fo rw ar d) tha n f or del ive ry n ow (s pot),th at c urr enc y i s a t Ah a t c urr enc y i s a t A
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Gray, Salter & RadebaughChapter 2
Premium or DiscountPremium or Discount
a PREMIU MREMIU M . IF THE SPOT FOR IS $1.5IF THE SPOT FOR IS $1.5PER AND THE FORWARD QUOTE IS $PER AND THE FORWARD QUOTE IS $
1.60 PER 1.60 PER ..
a Note : In the example $ AT A DISCOUNTNote : In the example $ AT A DISCOUNT ..
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Gray, Salter & RadebaughChapter 2
OPTIONS:OPTIONS: COMPUTING THE COSTCOMPUTING THE COSTAND BENEFIT OF AN OPTIONAND BENEFIT OF AN OPTION
aThis exercise first calculates theThis exercise first calculates the
cost of an option and then itscost of an option and then its
potential benefit.potential benefit.aThe example is for 30-day optionThe example is for 30-day option
to buy Japanese Yento buy Japanese Yenusing USusing US
Dollars.Dollars.a 30 days will take us to July.30 days will take us to July.
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Gray, Salter & RadebaughChapter 2
Computing Option CostComputing Option Cost
aThe rate we want to buy theThe rate we want to buy the
Yen at is $.00775 per .Yen at is $.00775 per .
aThe premium charged toThe premium charged to
execute such a contract is 1.64execute such a contract is 1.64
hundredths of a cent per hundredths of a cent per covered (dollars .000164 percovered (dollars .000164 per
).).
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Gray, Salter & RadebaughChapter 2
Computing AN OptionComputing AN Option
a Contracts come in blocks of 6,250,000.Contracts come in blocks of 6,250,000.The cost of a contract is as follows:The cost of a contract is as follows:
a Premium at .000164$/ *6,250,000Premium at .000164$/ *6,250,000$1,025$1,025
a Brokerage Cost (admin. fee)Brokerage Cost (admin. fee) $$2525
aTotal Cost per ContractTotal Cost per Contract
$1,050$1,050
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Gray, Salter & RadebaughChapter 2
A TYPICAL OPTION SCENARIOA TYPICAL OPTION SCENARIO
a Covering one hundred millionCovering one hundred million
(100mm).(100mm).
a How many contracts do weHow many contracts do we
need?need?
100 mm100 mm 6.25mm = 166.25mm = 16
Cost of cover: 16 x $1,050 =Cost of cover: 16 x $1,050 =
$16,800$16,800
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Gray, Salter & RadebaughChapter 2
Option Scenario : CostsOption Scenario : Costs
a Potential benefit: If the valuePotential benefit: If the value
of the exceeds $0.00775 perof the exceeds $0.00775 per
plus the transaction cost, we plus the transaction cost, we
can exercise the option andcan exercise the option and
sell the for a profit.sell the for a profit.
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Gray, Salter & RadebaughChapter 2
Option Scenario : CostsOption Scenario : Costs
Buy 100mm at $.00775/Buy 100mm at $.00775/
$775,000$775,000
Option Cost 16 contractsOption Cost 16 contracts$16,800$16,800
Additional admin. feesAdditional admin. feeson exercisingon exercising $400$400
TotalTotal $792,200$792,200
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Gray, Salter & RadebaughChapter 2
Option Scenario : BenefitsOption Scenario : Benefits
a If we sell the at .0080 $/, weIf we sell the at .0080 $/, we
have a profit of $7,800.have a profit of $7,800.
a At .0090 $/, the profit isAt .0090 $/, the profit is
$107,800.$107,800.
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Gray, Salter & RadebaughChapter 2
Classifying Risk and ExposureClassifying Risk and Exposure
a There are 3 types of foreign exchangeThere are 3 types of foreign exchange
exposure:exposure:
TransactionTransaction
TranslationTranslation
EconomicEconomic
Cl if i Ri k d E
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Gray, Salter & RadebaughChapter 2
Classifying Risk and Exposure -Classifying Risk and Exposure -
Transaction ExposureTransaction Exposure
a Transaction Exposure arises because weTransaction Exposure arises because we
do not have a method of accounting fordo not have a method of accounting for
multiple currenciesmultiple currencies
a Examples of Transaction Exposure includeExamples of Transaction Exposure include
purchasing or selling on credit, goods orpurchasing or selling on credit, goods orservices where the price is stated in aservices where the price is stated in a
foreign currency.foreign currency.
CCl if i Ri k d E
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Gray, Salter & RadebaughChapter 2
Classifying Risk and Exposure -Classifying Risk and Exposure -
Transaction ExposureTransaction Exposure
a How do we handle inherent risks?How do we handle inherent risks?
Prepare a separate budget for internationalPrepare a separate budget for international
cash flows.cash flows. This will allow you to assess if the volume ofThis will allow you to assess if the volume of
unhedged cash flows is significant.unhedged cash flows is significant.
Cl if i Ri k d ECl if i Ri k d E
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Gray, Salter & RadebaughChapter 2
Classifying Risk and Exposure -Classifying Risk and Exposure -
Translation ExposureTranslation Exposure
a Translation Exposure is when assets andTranslation Exposure is when assets and
liabilities on a balance sheet in oneliabilities on a balance sheet in one
currency, have to be re-expressed incurrency, have to be re-expressed inanother currency .another currency .
a Accounting for this has caused discordAccounting for this has caused discord
between financial regulators and thebetween financial regulators and thebusiness community.business community.
Cl if i Ri k d ECl if i Ri k d E
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Gray, Salter & RadebaughChapter 2
Classifying Risk and Exposure -Classifying Risk and Exposure -
Economic ExposureEconomic Exposure
a Economic Exposure involves uncontractedEconomic Exposure involves uncontracted
and unplanned changes in future cashand unplanned changes in future cash
flows which are the result of changes inflows which are the result of changes inexchange rates.exchange rates.
Cl if i Ri k d ECl if i Ri k d E
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Classifying Risk and Exposure -Classifying Risk and Exposure -
Economic Exposure ContdEconomic Exposure Contd
a Any decisions based on economicAny decisions based on economic
exposure are primarily long term.exposure are primarily long term.
a These decisions include choosing marketThese decisions include choosing marketand production facility locations.and production facility locations.