GLOBAL F I N A N C E
CORPORATE FINANCING FOCUS
Increased Volatility In Exchange Rates
Spurs Adoption Of Best Practices
In Currency-Risk Management
W alldorf,
Germain
based SAM
a leading business
software provider,
announced late in
the afternoon of January
11 that it would miss analysts' consensus estimates, as well as
Its own estimates, of fourth-quarter and full-year 2006
revenues. Later that day in NewYork, the company's
American depositary receipts lost 10.4% of their value,
lowering SAP's market capitalization by about $6 billion.
The German company, which generates a significant portion
of its sales revenue in the United States, was hurt by the decline
ofthe dollar against the euro. Since January 1,1999, SAP's
management and external accounting have been in euros.
"Foreign exchange volatility and surprises will not get a
fi-ee pass any longer," says Wolfgang Koester, CEO of Rim-
Tec, the Scottsdale, Arizona-based firm that operates
Fire.ipps, a technology and service that helps corporations
optimize their foreign exchange processes. "SAP is just the
latest proof of tbat," he adds.
European aerospace and defense contractor EADS in March
reported its second straight quarterly loss and warned that its
Airbus plane-making unit would post another substantial loss in
2{X)7 after losing money for the first time last year. The aircraft
maker was hurt not only by a two-year delay to its A380 super-
jumbo jet but also by a weak dollar against the euro.
Toronto-based Four Seasons Hotels suffered a foreign
exchange loss of $24.6 million in 2005, primarily as a result
ofthe translation of its US dollar and Britisb pound net
monetary asset positions to Canadian dollars using the
current exchange rates at the end of each quarter. The
MAY 20 07
company,
\\iiK"h has
^iiKc entered
into an
agreement to
be taken private,
now sells forward
US dollars to enable it to better predict tbe co.st in
greenbacks of its Canadian-dollar general and administrative
expenses and capital-funding requirements.
Four Seasons acknowledges that the new currency-
management program will not eliminate the impact of
foreign-currency fluctuations related to its management fees
in currencies other than US dollars. It will also not eliminate
foreign-currency gains and losses related to unhedged
positions. "A.S such, our consolidated results will continue to
include gains and losses related to foreign-currency
fluctuations," it said in a release. "The impact of foreign-
currency gains and losses has been material in the past and
could continue to be material in the future."
Many Still in Dark
Currency risk increases as companies do more of their
business outside of their home country. It is the risk that an
unfavorable change in the value ofa currency will result in
an unpredictable decrease in earnings, cash flow or value.
More and more companies are creating formal risk-
management policies to control tbeir foreign exchange risk,
but they still have a long way to go.
"Some 80% orcompanie.s don't know what their real
foreign exchange risk is," according to Koester. "Many
companies are using manual spreadsheets and bad data and are
failing to share information among divisions," he says. Rini-
 GLOBAL F I N A N C E

Tec last month launched Fireapps 3.5, the industry's first on- accelerating the effort to
dem.md foreign exchange risk-management platform. implement best practices in
The new software-as-a-service (SaaS) application provides currency risk management.
enhanced visibility into corporate foreign exchange "More companies are
exposures and analysis based on real-time currency and looking at managing such
internal banking data. For most companies, data are often risks that didn't previously
scattered throughout various business divisions in numerous because they weren't
locations and must be g;ithered and manually entered into international enough." says
spreadsheets. "In addition to time and resource concerns, Stephen Baird. principal at
using spreadsheets to calculate exposure opens companies up Chicago-based Treasury-
ro a high probability of error and inhibits them from making Strategies, a consulting firm
optimal exposure-management decisions," Koester says. serving corporations and
With Fireapps 3.5. companies can calculate risk exposures, financial institutions. "Now
including all inter-company accounts, in seconds. Once they there are lots of mid-size
measure their currency exposure, they can begin to manage companies that are
it by identifying natural hedges that either ah^ady exist or multinational corporations,"
can be created internally. Fireapps evaluates current foreign he says.
exchange exposures and provides the optimal ways to reduce It is becoming a trend
those exposures. for companies to imple-
ment a formal currency risk management process as opposed
Glorified Accountants to a case-by-case approach. "This formalization is a best
"Mt)st CFOs have become glorified accountants," Koester practice that has taken hold because of Sarbanes-Oxley
says. "They need to become strategic financial officers once reporting requirements," Baird .says.
again.' By taking a holistic view ofa company's foreign Corporate treasurers, who are generally responsible for
exchange exposure and understanding this exposure from an managing a company's currency exposure, are constantly ex-
(.'conomic point of view, the CFO can find die most posed to people pointing tlieir finger in their face, according to
effective way to reduce the risk and then implement Baird. "I call it die Mondiiy-morning quarterbacking problem,'"
hedging as a last resort to manage the remaining currency he says. "The CFO wants to know after the fact why the
risk, he says. Many companies still decline to actively treasurer hedged die dollar when the dollar went up, or \\'hy he
manage their foreign exchange exposure and avoid the use didn't hedge when the dollar went down."With a formal po-
of hedges, which are sometimes seen as a form of licy in place, the treasurer iiin reply to those with perfect 2(1/20
speculation. They may consider the effect of exchange rates hindsight tliat he was following an established practice when he
on market share and profitability but rarely have a formal made the decision whether or not to hedge, Baird points out.
policy of considering currency factors in the procurement
decision or where to source inputs. Not That Difficult
Fireapps can be integrated with foreign exchange trading Meanwhile, a growing number of companies are becoming
platforms to sn^eaniline transaction-management activities with comfortable with hedging forecasted exposures as they realize
financial institutions. A drill-down exposure analysis feature en- that hedge-accounting rules are not all that ditficult to
sures that decisions and risk-reduction actions are based on ac- comply widi, according to Baird. Financial Accounting
curate exposure data and are consistent with a company's risk- Standai-d 133 (FAS 133) is the accounting standard that
management policies and operational constraints, Koester says. pertains to derivative contracts and liedging activities.The u.se
ofa forward contract to lock in prospective currency rates
Mid-size Multinationals satisfies the criteria for cash-flow hedge accounting. If a
Globalization and a move toward lowest-cost sourcing, as well company knows that it will be importing parts for assembly,
as an increa.se in unexpected exchange-rate movements, are for example, it can create an effective hedge by purchasing a
currency forward m the amount
required to cover tbe import transaction
MICROSOFT'S ONE-DAY VALUE-AT-RISK POSITION ($millions)
at a specified exchange rate on the
Year ended June 30, 2006 p,iyiiieut-due date.
RIsK Categories 30-Jun-06 30-Jun-05 Average High Low Transaction exposure differs from
Interest rates 66 88 82 127 62
translation exposure, which is related
Currency rates 91 52 33 91
to the location of a company's assets.
11
The value of assets in a foreign
Equity prices 88 164 116 166 84
country has to be translated into the
Commodity prices 12 14 i L T 15 18 12
reporting currency ofthe home
Source: Microsoft country to consolidate accounts for

0 C7
 GLOBAL

reporting purposes. Economic exposure relates to the

CURRENCY FORECASTS
currency used to measure revenue and costs. Companies
should look at foreign exchange risk first from an economic
viewpoint, says Koester of Rim-Tec. "Make economic
decisions and then account for them," he says. "Understand
your exposure, look at ways to reduce it optimally and
then hedge."

Doing a Good Job A M J J A S O N D J F H l U J J A S D K D j r M

Among companies that are doing a good job of managing

their currency risk, Koester cites Google. Procter & Gamble
and Microsoft. Redmond, Washington-based Microsoft
hedges a portion of its anticipated revenue and accounts
receivable exposure to foreign-currency fluctuations.
primarily with option contracts. It monitors its foreign
exchange exposures daily to maximize the overall
effectiveness of its foreign-currency hedge positions. The A M J J A S O N D J F M A M J J A S O N O J F M

main currencies it hedges include the euro, the yen, the

British pound and the Canadian dollar.
Microsoft uses a value-at-risk (VaR) model to estimate and
quantify its market risks in foreign-currency, interest rate.
equity and conunodity-price risks. VaR is the expected loss,
for a given confidence level, in the fair value of its portfolio
Source: The Bgnh of New Voik
due to adverse market movements over a defined time period. l U A M J J t S O N D

"The VaR model is not intended to represent actual losses in

fair value but is used as a risk estimation and management Switicrlana

tool." the company says in its annual report tor 21KK). (Franc/USSl

VaR is calculated by computing the exposures of each hold-

ing's market value to a range of more than 1,000 risk factors.
Microsoft notes that several risk factors are not captured in the
model, including liquidity risk, operational risk, credit risk and
legal risk. "Losses in fair value over the specified holding A M J J K S O N D J

period can exceed the reported VaR by significant amounts

and can also accumulate over a longer time horizon than the
specified holding period used in the VaR analysis" the
company says.

Fluctuations Getting Bigger

The recent increase ui foreign exchange market volatility A M J J A S O N B j F M A M J J A 5 Q N D
was triggered by a variety of factors, including a wave of
carry-trade unwinding in the year-end 2{l<!6 period and big
swings in glohal equity markets following the 9% one-day
plunge in China's stock market in late February. While
several emerging market currencies came under attack
during this period, they have since recovered.
Meanwhile, the dollar's shaky foundation wentfix)mbad
to worse in mid-April as the greenback hit a new two-year A M J J A S O N O J F M / k M J J A S D N D

low against the euro, a 17-ye.ir low against the Australian

dollar and a new low for the year against the Canadian
dollar, says Ashraf Laidi. chief foreign exchange analyst at
CMC Markers in New York. Rising prices of oil. gold and
other metals, as well as rate-increase expectations, are behind
the surge in the Australian dollar, he notes. Expectations of
higher interest rates are also supporting the euro, he says.
"The yen remains the consistent loser, ofi^ermg some F M A f r i J i A S D N S J F M

relief to the dollar," Laidi says. Market participants began

2 0 0 7 MAY 7 5

moving back into yen carry-trades last month, as the Bank
of Jnpan continued to express caution about the risk of
renewed detlation.
Despite confirmation in the Litest Federal Open Market
Cxjinmittee meeting minutes thjt inflation remains the prin-
cipal risk to the Federal Reserve's economic as.sessnient, the
dollar remains overshadowed by the risk of liirther economic
slowing at home and robust growth abroad, according to Laidi.
Putting a Cap on 'Cable'
lalk ot (avorable tax laws to allow Britain-based companies
to repatriate foreign profits t;ix-free triggered a sharp rally in
the British pound la.st month, but Laidi says the UK
currency should start to gradually form a top against the
dollar. Preliminary steps by Britain's Financial Services
Authority to investigate the country's sub-prime mortgage
market have started to weigh on the pound, he says. The rise
ill the UK's February trade deficit also is helping to cap
"cabU'," as the pound is known, he notes.
The better-than-expected US employment data for March
failed to provide the dollar with any lasting gains. The dollar
was engulfed by a new wave of selling after the US
aiiministration said it would tile compiaints at the World
Trade Organization targeting China's piracy of US
copyrighted movies, music, software and books. The action
sparked worries of potential retaliatory acts by Beijing, Laidi
says. "History has shown consistent empirical evidence that
nations pursuing protectionist rhetoric will experience
declines in tiie value of their currencies," he says.
The WTO action followed the US Commerce
l_')epartment's announcement ofthe imposition of
countervailing duties on imports of coated paper, not only
from China, but also fixim South Korea and Indonesia.
"While there is no reason to link this to previous threats
by the US Congress to apply a 21. WD tariff against
Chinese imports, the market's reaction demonstrates how
sensitive an issue this is." says Michael Woolfoik, senior
CURRENCY FORECASTS
A l i l J J l S O M D J f M l M J I K % 1 H :• 1
n M . I J A S O N D J f M A M J J * £ O N D J F M
M A Y 2 0 0 7
FINANCE
currency strategist at The Bank of NewYork.
A Lose-Lose Scenario
"Pujtectionist taritB are widely viewed as a lose-lose scenario f(.)r
both the US and Chinese economies," Woolfoik says. "A trade
war is the very thing that could push the US economy, already
teetering on the edge ofa recession dependent on tbe outcome
o\ the sub-prime workout, decidedly over the precipice."
Thanos Papasawas, head of currency management at
London-based lnvestec Asset Management, says the first
quarter of 2(107 brought a pickup in volatility across all as.set
classes, with currency markets badly whipsawed during
February and March. All major currencies appreciated
against the dollar in March, with currencies ofthe resource-
producing countries performing particularly well.
"We expect the Fed to cut rates by 25 basis points while
the Bank of Japan and the European Central bank tighten
by the same amount during the summer," Papasa\'vas says.
"The interest-rate differential will continue to play against
the greenback against aU the majors save the yen." he says.
High-Water Mark for Euro?
As the first quarter ended, one of the key features for
policymakers and investors wa.s an increase in uncertainty,
says Marc Chandler, global head of currency strategy at
Brown Brothers Harriman in NewYork."In many ways,
what happens in the second quarter may very well set the
tone for the rest ofthe year." he says. For one thing, the
outlook for the US economy should become clearer.
If the Fed is right and the US economy strengthens in the
second half, then the second quarter could mark an
important high for the euro. Chandler says.The risk is that by
the end of tbe second quarter the European Central Bank
will have braught its refinancing rate to 4%, a level tbat it
regards as neutral, he adds. "It may pause and wrestle with the
same dilemma that the Fed has: how to pause without
signaling the end ofthe cycle," he says. —Gordon Plou
FM