International Treasurer

Mexico's Maxi

janu ary 9, 1995

page 7

Responses to the
deva lu ation of the
Mexica n peso.

The Corporate Treasurer's Guide to Global Financial Management

More Derivatives
Disclosure Guidance
Country profil e

Co nfere nce bri efin g

Mexico's Maxi

More Derivatives
Disclosure Guidance

By joseph Neu
The Mexico story isn't over-and perhaps the
year-end peso fall will be the easy part.

Talk to a/most any MNC treas urer las t wee k

and you wou ld hear them worry o ut loud
about the peso crisi s. M ax i-deva lu ations of 40
percent w ill do th at. Treas urers th at took our
advice ("M ex ico: Tim e to Look for Cove r?",
IT, 8/8/94) and looked to hedge peso pos itions
m onth s before th e e l ect ion s are probab l y
happy th ey did . H oweve r, eve n thos e w ho
managed their hedges perfectly now have to
come to terms with ope rations in M ex ico that
w ill be in for hard eco nom ic tim es until at
least 1996.

The other shoe to drop

A lot of banks and co mm erc ial co ncer ns in
M exico, both indi ge nous an d foreign , have
been funding in dollars on an unhedged bas is.
The cost of hedging was simp ly too hi gh (c.a.
10%) and the belief in co ntinued currency stability seeming ly too ce rtain for th em to do otherwi se. Today these entities face exchange rate
losses, higher interest costs, and less free cash.
These higher interest costs w ill con tribute to
economic deteriorat ion . A s banks ti ghten
credit, companies and their custo mers w ill be
less ab le to pay th ei r debts. Foreign MNCs
w ith non-expo rt Mexican operations w ill need
to move to a cost c uttin g and conta inm ent
posture.
As one international assistant treasurer put it:
"this is a good reminder as to why we set high
risk premiums and exercise centralized capital
controls on intercompany funding to our operations in countries like Mexico."
One of the few good things about a m ax ic urrency deva lu ati o n is th at th ey are over
qu ick ly. Th at this deva lu atio n came over the
continued on back page

By Hal Davi s
The FEI's disclosure seminar offers some practical disclosure guidelines, yet continues to support the view that financial risk education will
do more than accounting numbers.

Th e Finan c ial Exec uti ves In stitute (FEI ) hosted

the first of two recent se min ars on co rporate
disclosure in Wash in gto n, D. C., Decemb er
22 . Its aim was to help co rporate derivative
users prepa re for new di sclos ure requirements.
Like the FEI 's Derivatives Di sclosure Task Force
(see IT, 12/ 12/94), th e se min ar's mess age,
endo rsed by most participa nts, was th e need
for co mpani es to ex pl ain th eir use of derivatives in th e context of the und erl yin g f in anc ial
risks of norm al bu sin ess. Yet, o n the hee ls of a
500 co mpany review o f disc los ure ex ampl es,
th e SEC wi ll cl ea rly be looking for more spec ific derivatives disc los ures.

The FEI continues its

efforts to help corporates sort out their
derivative disclosure
actions.
page 7

What Central
Banks Say
G-1 0 central banks
revea l a line of thin king w here financia l
risk discl osure is done
o ut of se lf-i nterest.
p age3

Using Options to
Forecast FX Rates
New uses for options
vo latility information:
testin g the cred ibility
of fixed rate currency
regimes.
p age4

MG's "Baby with the

Bath Wate('
The M eta ll gesellschaft
losses revea l potential
intellectu al ri sks that
every company
shou ld be aware of.

The seminar in brief

Edu ca tion being key to the current deri vatives

disc los ure debate, the seminar bega n with a
pr im er on fin anc ial risk mana gement. In thi _,__ p age 6
sess ion, Dav id M engle, a JP Morgan vice pres id e nt , shared some key co nce pts from the
The Treasury
recentl y publi shed JP Morgan/Arthur And erse n
Professional
Guide to Corporate Expos ure Management
Treasurers can
publi shed by Risk magaz in e. Mr. M engle disin crease th eir value
cussed the need for co mpani es to integrate the
added by pursuing
management of fin ancia l ri sks ari si ng in co re
continual process
b usin esses w ith th e ir st r ateg i c pl annin g.
improvement and
D ec id in g which ri sks to take and which to
objective benchmarks.
hedge, th en beco mes ce ntral to overa ll bu sipage 7
ness man age ment. Thi s th eme th en ca n ca rry
over into q uali tat ive disclosure discussions .
Next, ca me the co rporate presentations, featur in g three represe ntat ives from th e FEI Tas k
Force: C itiba nk, Dow Chemica l, and Mobil .
Ea ch foc used on ways in w hi ch th eir compacontinued on page 2

The Back Page

Editor & Publisher

Joseph NeLl

Contributing Editors

con tinued from page 1

ho lid ays mea ns t hat most treasurers ca n sta rt

the new year fres h w it h a w eak peso as th e
new rea lity.

What to do now?
Th e foll ow ing is a partial li st of thin gs treas urers ca n do to man age this new rea lity.
Don't panic. As noted abo ve , th e re is
nothin g th at ca n be don e to fix imm ediate
losses . Non- hedge rs, w ho did not track th e
perfo rman ce of past borrowin g d ec isions ,
sho uld co nsider doing so going forward.
" My guess is," says Dr. j acob Feldm an, internatio nal treasury d irector at M erck, " th at most
compani es w ill find th at th e cost of hedg in g
doll ar borrowi ngs ove r tim e is more tha n th at
amount lost in one max i-deva lu ation . Th e bottom lin e is that you need th e performa nce
nu mbers to answer t hi s kind of q uestion. "
Presentin g these numbers to se ni or management is also a way to defe nd treas ury's past
dec isio ns and to ca irn internal panic.

Test the accuracy of exposure management systems. Th e fa ct th at this deva lu ation

occurred at year-e nd, facilitates a qui ck com parison of losses reported by M ex ica n affili ates
w ith those identified by int er na l expos ure
m anage m ent systems . Often ma x i-deva lu ations br ing hidden exposures to light, and takin g steps to prevent simi l ar expos ures from
be in g hidden in the future is a prudent action .
Do a cash forecast. In li ght of an antic ipated eco nomic slowdown , with de laye d paym en ts and defa ult, now i s a good tim e to
rethink ea rnin gs projections . Talk w ith marketing to see if any new pri c in g strategies m ay be
impl emented.
Start cutting costs. Most revised cash-fl ow
fo recasts fo r operations se llin g in Mexico wi ll
revea l the need to co ntain or redu ce costs significantly. Treasury manage rs with long experience in Latin America try to move into thi s
containment posture befo re a devalu ation , by
sca lin g bac k when thin gs look too good, so
th ey do not get caught w ith large rece ivab les.
Some co mpa ni es wi ll be looking at c hangin g
so urc ing from the US . Th e currency ex posure
of such so urc in g decisions sho ul d become part
of futu re cost assess ments.
Develop an FX forecast. Based on this forecast, so me co mp ani es may want to co nsid er
changi ng fu nding strategy to local curre ncy . If
you have th e funds, pay down loca l currency
loa ns w hil e th e currency i s c heap. Interest
ex pense drain s li qu idity as cas h flow gets ti ght.
8

Hal Davis

Look out for exchange controls. With

Venez uela sti ll fres h in eve ryone's mind, treasu rers shou ld inform thei r staff to keep an ea r
o ut for market rumors that suggest th e poss ibil ity of exc hange co ntro ls. Whil e exc hange co ntro ls are not anti cipated-l est M ex ico lose ten
in stead of two year's of eco no mi c prog ress- if
there are persistent rumors, they should not be
igno red.
-

Don't Be Misled by an Improving Picture

Unlike fund managers, most corporate treasurers
have lon g-term, d irect investm ent pos itions in the
peso and wi ll not move their remaining money out
under im proving market condi tions, as Ba nk of
America Economi st Gu ill ermo Estebanez says may
happP.n- pa rti cularl y, w hile th e US government-led
$18 billi on credit line is in place. Nea r-term market
improvements may be short- lived.
One of the few bank econom ists to predi ct both
the timi ng of th e peso max i-deva luation and the
subseque nt dec ision to f loat it, San Franc iscobased Mr. Esteba nez is also amo ng those look ing
for economi c deterioration to co ntinue until 1996.
Overva lued assets in the domestic sectors of the
eco nomy wi ll have to come clown before exportled growth can return the co untry to sou nd econom ic foot ing.
Wi ll Argentina break cl own too? Most treasurers
have th eir eyes on Argenti na to see if and w hen it
m ight be next. Argentina has been emulati ng much
of th e M ex ican prototype since 1992 and has also
received signifi ca nt fore ign capital inflows . In his
recent Forbes article, our new academic advisor
Steve H anke argues th at a curre ncy board-l ike system, w ith a peso fixed 1 :1 agai nst the do ll ar (see
"The Currency Boa rd Trend ," IT, 11 / 14/94), w ill
save Argentin a from M exico ' s fate.
Though not everyo ne has as muc h fa ith in th e
currency board concept, most observers expect
Argentina to ho ld off o n a possible deva luati on
unli l after th e M ay elections, o r even unti l it ga ins
NAFTA entry in 1996-97.

Welcome
W e take thi s opportunity to we lco me two new
names to our masthead.
The first is Hal Dav is, w ho jo ins as a co ntributing ed itor. M r. Dav is is an indepe ndent researcher
and consul ta nt, and has written severa l studies o n
treasury and corpo rate finance fo r the Financi al
Executives Resea rch Fo und atio n.
The second is Steve H anke, professor of app lied
eco nom ics at The johns Hopkins U ni vers ity, w ho
jo in s our group of academ ic advisors . H is article
on Meta llgese ll schaft' s ri sk management problems
appears on page 6 . Mr. H anke is an adv iso r to sev- 1
1
eral emerging market eco nomi es and is a stro ng
proponent of currency boa rds.

Donald D unn
Profess ional Contributors

Robert Herz
Associa te Nalional Direc tor of

Accounting and SEC Services

Coopers & Lybrand
Peter Con nors
D irecto r, T ax Se rvices
ln\ernat\ona\ Capita\ Markets
Ern st & Young

Jeffrey Wa llace
Manag ing Director
G reenwich Treasury Advisors
David Veres
Pa rt ner
Rogers & Well s

Corporate Advisors
H ans Pohl sc hroeder
Ass istant Treasurer
Col gate-Pillrnolivc
D avid Rusa te

Assistant Treasurer
Genera l Electric
Arvind Sodhani
Vice Pres ident and Treasurer
Intel Corp.
A. John Kearney
Assistant Treasurer
Merck & Co.

Juanita Hinshaw
V ice Pres ident and Treasurer
M onsa nto
Academi c Advisors
Lee Rem mers
Professo r
IN5EAD
Donald Lessard
Pro fesso r
M assachusetts
Insti tute of Tech nology

Richard Levich
Pro fessor
Stern School of Business
New York Universi ty

Steve H anke
Professor
The Johns H opkins U ni versi ty

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