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Risk Management Strategy Joy McAlister November 4, 2003
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Overview Short-run transaction management Diversification Routing cash balances Payments netting Leading and Lagging Re-invoicing Intermediate-run operations management Marketing and Production management Managing net worth exposure
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Short-Run Transaction Management Management Decision: To centralize or decentralize management of foreign exchange risk and international cash balances.
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Diversification Centralization Reduces the number of hedge transactions overall Economies of scale Reduces risk through diversification Decentralization Potential for excessive hedging Does not lead to portfolio effect
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Routing Cash Balances In a centralized organization, the cash depository serves as a pooling center for international currency. Protects from borrowing at high interest rates and saving at low interest rates Facilitates currency conversion Lower transaction costs
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Payments Netting A goal of centralized transaction management is to reduce the number of intra-company payments. Payments netting can reduce the amount of currency transferred between departments/subsidiaries Multilateral payments netting Reduces transactions Facilitates currency conversion
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Leading and Lagging “A method of routing cash balances by using the payments netting system, which accelerates payments to a subsidiary that needs cash and delay payments from the same subsidiary that are due all other subsidiaries.” Increased asset liquidity for subsidiaries
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Re-invoicing Process of import and export transactions in favor of each subsidiaries home currency. Under centralization model, management accepts transaction exposure and foreign exchange risk Subsidiary is left to operate exclusively in home currency
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Intermediate-Run Operations Management Managing Cash Flow Exposure Objectives: Manage revenue through marketing Manage costs through production Pre-planned flexibility Active response to exchange rate signals
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Marketing Management Increase sales in countries where currency is overvalued and decrease sales in countries where currency is undervalues – in respect to PPP. Marketing impact on marginal revenue vs. cost Product design as a component of marketing strategy Pricing strategy
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Production Management Focus on countries where the currency is undervalued. Production should be in a country that is a low- cost producer Sourcing from low-cost producers
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Managing Net Worth Exposure Management concern is the underlying currency denominations of the firms assets and liabilities. Balance sheet hedge is a way to manage economic exposure through structuring the balance sheet exposure to offset a firm’s income statement exposure.
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Current Risk Management Examples www.garp.com www.contingencyanalysis.com
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