HEDGING OF FOREIGN CURRENCY CASH FLOWS

This website was created and maintained by:
Adrian Mihalko, Thomas Derhammer, Adriel Amaro, Scott Sheer, Tamir London.

As we move into the 21^st century, the degree of interdependency within the global economy is soaring to unprecedented levels. Not only are domestic companies exporting and importing a greater amount and variety of goods from businesses in other countries, many companies are becoming multinational. The increase in the depth and scope of the global economy presents businesses and corporations with a major issue regarding the management of their operations—the management of risk associated with foreign currency exposure. In particular, many companies implement a risk management structure to insulate themselves against foreign currency exposure utilizing a concept known as hedging.

Hedging involves structuring business transactions and activities to reduce any associated risks. Foreign currency transactions are the primary focus of foreign currency cash flow hedging. When dealing with foreign currency items, a business is always faced with the prospect of being adversely affected by currency exchange rates; and such changes can often be volatile. Depending on what side of a sale or purchase transaction a company is on, appreciation or depreciation of the home currency can result in significant changes in the amount of cash flowing into and out of the business. Hedging foreign currency risks involves protecting the business from losing cash due to a change in the exchange rate that would decrease the amount due from a customer or increase the amount paid to a supplier. This page focuses on providing methods, examples, and theoretical issues relating to the implementation of foreign currency cash flow hedges. The links displayed below discuss currency swaps, currency forwards, currency options, and other tools to hedge foreign currency transactions, examples of companies who employ risk management of foreign currency cash flows, and Financial Accounting Standards Board responses to implementation issues connected to Board pronouncements.

Methods of Hedging Foreign Currency Transactions

Futures Currency Swaps -The Very Basics

This page is excellent for those desiring a clearer understanding of currency swaps. The author provides an example where a U.S. company employs a currency swap to hedge its exposure to the changes in the exchange rate of the GermanMark when issuing a bond to borrow the said currency.

Standards of Sound Business and Financial Practices--Foreign Exchange Risk Management

This page, maintained by the Canada Deposit Insurance Corporation, describes the role of this organization in promoting proper business management and handling of foreign currency risk exposure in Canadian business firms. Here, the CDIC provides guidelines for establishing hedging and risk management policies, focusing on measurement of foreign exchange risk, establishment of controls over foreign currency transactions, and the use of evaluation techniques.

The Supervisory Treatment of Market Risks--Foreign Exchange Risk

Deviating a bit from the topic of foreign currency cash flow hedges related to risk management in business, this article describes the steps banks take in hedging foreign currency exposure risk. Banks first measure risk exposures in a single currency then determine the foreign exchange risk with the amount needed to absorb the estimated risk. Two methods, the shorthand method and the simultaneous method, are used in this procedure.

Foreign Exchange Exposure

This site provides an easy to understand explanation of the concept of cash flow exposure, while also trying to tie the implication of foreign currency transactions. In particular, computations of foreign currency cash flow risks are computations of foreign currency cash flow risks are discussed and actually computed for a real company, while the site includes exchange rates on contracted exposure. Other information provided includes evaluating exposure through pro forma statements.

Financial Derivatives and Foreign Currency Risk

This paper (project) on Financial Derivative and Foreign Currency risk gives excellent background information with regard to the concept of using financial derivatives as hedging vehicles. It also contains a specific example of foreign currency hedging between a U.S. and Japanese country, describes typical foreign currency hedging instruments such as currency options, swaps, and forwards, and the concept of a quanto swap.

Implementation Derivatives Implementation Group: Statement 133 Implementation Issue No. H4

Before investing in foreign countries we have to setup the following formula to make sure that it is a stable investment.

Implementation Issues and Financial Accounting Standards

Text and Summary of Statement No. 133

This site provides the text of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. It includes the regulations governing classification of certain derivatives as hedges and, in particular, standards for implementing foreign currency cash flow hedges.

Derivative Instruments and Hedging Activites: The New Requirem

This site gives a detailed interpretation by Grant Thornton, an international management and accounting firm, at the components of FASB’s SFAS No. 133, which amends and supercedes earlier pronouncements regarding accounting for hedging activities using derivatives, particularly foreign currency cash flow hedges. It outlines, in simplified language, the definition of a hedged foreign currency transaction, along with the requirements necessary.

Derivatives Implementation Group: Statement 133 Implementation Issue No. H3

Taken from the Financial Accounting Standards Board website, this page discusses an implementation issue related toSFAS No. 133 regarding hedging the risk of foreign currency exposure involved in the sale of an asset using the cash flow hedging model.

Introduction to FAS 138 Amendments and Some Key DIG Issues

This page, developed by a professor from Trinity University for use at workshops for KPMG Peat Marwick workshops, includes a detailed breakdown of FAS 138, along with discussion of various implementation issues associated with then statement.

Swaps Ahoy! Should Regulators Voyage Into Unknown Waters?

Maintained by the Indiana University School of Law-Bloomington, this site examines the breadth of regulation of currency swaps, and makes recommendation as to where this authority should reside and what new forms of regulation must be implemented in the future. Organizations such as the CFIC and SEC have traditionally held the power to field regulation. However, the CFIC has since relinquished much of its control, while the roles of the SEC and FDICIA, and >individual banks have increased. The future appears to hold an increase in the use of currency swaps and the need for more stringent regulation.

Under the Wire! Statement 138 Amends FAS 133

This page, part of the Delotte & Touche web-site section devoted to updates in accounting and financial reporting . It contains a full explanation of SFAS No. 138, created to amend SFAS No. 133. The page provides information on the new regulations as to foreign currency.

Derivatives Implementation Group: Statement 133 Implementation Issue No. H5

This page describes a particular implementation issue related to SFAS #133; specifically foreign currency cash flow hedges. The party in question desired clarification as to whether the sale of the sale of non-financial asset qualifying as a normal sale could be hedged, if the sale agreement qualifies as a firm commitment. Further, if the sale agreement is not a firm commitment but contains a foreign currency-dominated fixed price, the party questions whether the fair value hedging model or the cash flow hedging model may be used. The FASB responded affirmatively to the first issue, but stated that the fair value hedging model may not be used if the sale contains a currency-dominated fixed price. However, the party may use the cash flow hedging model in this situation.

Company / Industry – Specific Foreign Currency Hedging

The Impact of Currency Fluctuations

This page describes the impact of foreign currency fluctuations on the profit before tax and earning predictability, along with the hedging policy, of Novo Nordisk Group. Novo Nordisk uses forward contracts, borrowing, swaps, options, and other financial instruments to hedge the effect of rate fluctuations on foreign currency cash flows from foreign currency transactions. The policy is designed to hedge new exposure 1 year ahead, with the general goal being to stabilize operating income.

Notes to Consolidated Financial Statements: Mitsui & Co., Ltd. and Subsidiaries

This page gives the notes to the financial statements for Mitsui, Co., Ltd. And subsidiaries. In particular, the notes contain a good example of the disclosure of risk management policy.

Foreign Currency Accounting: How To Avoid Losses and Minimize Volatility

This page, part of a spotlight by Pricewaterhouse Coopers on foreign currency issues in Ireland, shows why Irish businesses and companies are having to deal with increased currency fluctuations affecting their accounts, due to increases in exports and imports, along with the purchase of foreign operations. To manage the resulting risk, companies have bought foreign currency, borrowed foreign currency, and expanded the international breadth of the shareholders. These hedging activities have resulted in various reporting issues detailed in the article.

Development of Foreign Currency Risk Exposure Management

Currency Exposure: Growth In Foreign Currency Exposure

This page examines how the increase in globalization of business has caused increases of concern and motive to deal with foreign currency exposure. It also points out that firms doing business domestically need to practice risk management to stay competitive with the prices of competitors who do business internationally. Finally, the page details a specific example of transaction exposure between currencies.

What Is Hedging? Why Do Companies Hedge?

This article provides one with a clearly developed discussion of the concept of hedging along with the approach companies should take with risk management. It defines several objectives to consider with respect to planning hedging activities.

Indeed, the idea of developing a risk management strategy to compensate for foreign currency exposure, not to mention the concept of hedging foreign currency cash flows, are both hot topics in the business world. Once businesses identify their exposed risks and ask themselves how much cost they are willing to incur, they can begin to develop a comprehensive plan for managing those risks, including risks associated with cash flows from foreign currency transaction exposures. Firms such as the CDIC (Canada Deposit Insurance Corporation) and the Financial Risk Institute (IFCI) are examples of companies who provide consulting services in risk management matters. Again, firms may utilize currency swaps, currency forwards, currency options, and currency futures to hedge the effects of changes in the exchange rate between the home currency and the foreign currency.

In the United States, the FASB (Financial Accounting Standards Board) issued its Statements of Financial Accounting Standards # 133 to provide theoretical guidance in developing, reporting, and recognizing foreign currency cash flow hedges. Statement No. 138 further qualifies that what derivative instruments and activities qualify as hedging activities. Finally, there have been a number of implementation issues associated with SFAS No. 133, including whether foreign-currency interest payments, firm commitments, fixed-price agreements, can be hedged using the foreign currency cash flow model.


Methods of Hedging Foreign Currency Transactions

	Futures Currency Swaps -The Very Basics
		This page is excellent for those desiring a clearer understanding of currency swaps. The author provides an example where a U.S. company employs a currency swap to hedge its exposure to the changes in the exchange rate of the GermanMark when issuing a bond to borrow the said currency.

	Standards of Sound Business and Financial Practices--Foreign Exchange Risk Management
		This page, maintained by the Canada Deposit Insurance Corporation, describes the role of this organization in promoting proper business management and handling of foreign currency risk exposure in Canadian business firms. Here, the CDIC provides guidelines for establishing hedging and risk management policies, focusing on measurement of foreign exchange risk, establishment of controls over foreign currency transactions, and the use of evaluation techniques.

	The Supervisory Treatment of Market Risks--Foreign Exchange Risk
		Deviating a bit from the topic of foreign currency cash flow hedges related to risk management in business, this article describes the steps banks take in hedging foreign currency exposure risk. Banks first measure risk exposures in a single currency then determine the foreign exchange risk with the amount needed to absorb the estimated risk. Two methods, the shorthand method and the simultaneous method, are used in this procedure.

	Foreign Exchange Exposure
		This site provides an easy to understand explanation of the concept of cash flow exposure, while also trying to tie the implication of foreign currency transactions. In particular, computations of foreign currency cash flow risks are computations of foreign currency cash flow risks are discussed and actually computed for a real company, while the site includes exchange rates on contracted exposure. Other information provided includes evaluating exposure through pro forma statements.

	Financial Derivatives and Foreign Currency Risk
		This paper (project) on Financial Derivative and Foreign Currency risk gives excellent background information with regard to the concept of using financial derivatives as hedging vehicles. It also contains a specific example of foreign currency hedging between a U.S. and Japanese country, describes typical foreign currency hedging instruments such as currency options, swaps, and forwards, and the concept of a quanto swap.

	Implementation Derivatives Implementation Group: Statement 133 Implementation Issue No. H4
		Before investing in foreign countries we have to setup the following formula to make sure that it is a stable investment.


Implementation Issues and Financial Accounting Standards

	Text and Summary of Statement No. 133
		This site provides the text of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. It includes the regulations governing classification of certain derivatives as hedges and, in particular, standards for implementing foreign currency cash flow hedges.

	Derivative Instruments and Hedging Activites: The New Requirem
		This site gives a detailed interpretation by Grant Thornton, an international management and accounting firm, at the components of FASB’s SFAS No. 133, which amends and supercedes earlier pronouncements regarding accounting for hedging activities using derivatives, particularly foreign currency cash flow hedges. It outlines, in simplified language, the definition of a hedged foreign currency transaction, along with the requirements necessary.

	Derivatives Implementation Group: Statement 133 Implementation Issue No. H3
		Taken from the Financial Accounting Standards Board website, this page discusses an implementation issue related toSFAS No. 133 regarding hedging the risk of foreign currency exposure involved in the sale of an asset using the cash flow hedging model.

	Introduction to FAS 138 Amendments and Some Key DIG Issues
		This page, developed by a professor from Trinity University for use at workshops for KPMG Peat Marwick workshops, includes a detailed breakdown of FAS 138, along with discussion of various implementation issues associated with then statement.

	Swaps Ahoy! Should Regulators Voyage Into Unknown Waters?
		Maintained by the Indiana University School of Law-Bloomington, this site examines the breadth of regulation of currency swaps, and makes recommendation as to where this authority should reside and what new forms of regulation must be implemented in the future. Organizations such as the CFIC and SEC have traditionally held the power to field regulation. However, the CFIC has since relinquished much of its control, while the roles of the SEC and FDICIA, and >individual banks have increased. The future appears to hold an increase in the use of currency swaps and the need for more stringent regulation.

	Under the Wire! Statement 138 Amends FAS 133
		This page, part of the Delotte & Touche web-site section devoted to updates in accounting and financial reporting . It contains a full explanation of SFAS No. 138, created to amend SFAS No. 133. The page provides information on the new regulations as to foreign currency.
	Derivatives Implementation Group: Statement 133 Implementation Issue No. H5
		This page describes a particular implementation issue related to SFAS #133; specifically foreign currency cash flow hedges. The party in question desired clarification as to whether the sale of the sale of non-financial asset qualifying as a normal sale could be hedged, if the sale agreement qualifies as a firm commitment. Further, if the sale agreement is not a firm commitment but contains a foreign currency-dominated fixed price, the party questions whether the fair value hedging model or the cash flow hedging model may be used. The FASB responded affirmatively to the first issue, but stated that the fair value hedging model may not be used if the sale contains a currency-dominated fixed price. However, the party may use the cash flow hedging model in this situation.


Company / Industry – Specific Foreign Currency Hedging

	The Impact of Currency Fluctuations
		This page describes the impact of foreign currency fluctuations on the profit before tax and earning predictability, along with the hedging policy, of Novo Nordisk Group. Novo Nordisk uses forward contracts, borrowing, swaps, options, and other financial instruments to hedge the effect of rate fluctuations on foreign currency cash flows from foreign currency transactions. The policy is designed to hedge new exposure 1 year ahead, with the general goal being to stabilize operating income.

	Notes to Consolidated Financial Statements: Mitsui & Co., Ltd. and Subsidiaries
		This page gives the notes to the financial statements for Mitsui, Co., Ltd. And subsidiaries. In particular, the notes contain a good example of the disclosure of risk management policy.

	Foreign Currency Accounting: How To Avoid Losses and Minimize Volatility
		This page, part of a spotlight by Pricewaterhouse Coopers on foreign currency issues in Ireland, shows why Irish businesses and companies are having to deal with increased currency fluctuations affecting their accounts, due to increases in exports and imports, along with the purchase of foreign operations. To manage the resulting risk, companies have bought foreign currency, borrowed foreign currency, and expanded the international breadth of the shareholders. These hedging activities have resulted in various reporting issues detailed in the article.


Development of Foreign Currency Risk Exposure Management

	Currency Exposure: Growth In Foreign Currency Exposure
		This page examines how the increase in globalization of business has caused increases of concern and motive to deal with foreign currency exposure. It also points out that firms doing business domestically need to practice risk management to stay competitive with the prices of competitors who do business internationally. Finally, the page details a specific example of transaction exposure between currencies.

	What Is Hedging? Why Do Companies Hedge?
		This article provides one with a clearly developed discussion of the concept of hedging along with the approach companies should take with risk management. It defines several objectives to consider with respect to planning hedging activities.