Cost-Benefit Analysis for FX Risk Management

Transcription

1 Cost-Benefit Analysis for FX Risk Management Ming Huey Global Treasury Manager Salesforce.com, Inc. Tony Capozzoli, Ph.D. Director, FX Risk Solutions Deutsche Bank

2 Session overview 1) Why cost-benefit analysis? 2) FX risk management 3) Measuring benefit and cost 4) Balance sheet and cash flow hedging programs 5) Evaluating strategies and programs

3 Why cost-benefit analysis? Tony Capozzoli Deutsche Bank

4 Estimated contribution to firm value, from a global survey of CFO s 3.8% 7.0% Risk management activities All other financial management functions (as a % of firm market value)

5 CFO s on risk management ( RM ) 60% willing to estimate RM s contribution to firm value >80% of these CFO s say that RM adds more value than the direct resources it consumes Does your CFO have an estimate of added value relative to cost?

6 Cost-benefit analysis If we could map out the benefits and costs of hedging, we could: Evaluate individual hedging strategies Evaluate an entire hedging program Communicate program value internally

7 FX risk management Ming Huey Salesforce

8 FX Risk Management Overview How does FX impact a company? What are the typical objectives of a company s FX hedging program? Do companies usually hedge all exposures? If not, how do you decide which exposures are material?

9 Measuring the costs and benefits Tony Capozzoli Deutsche Bank

10 What are the benefits? Risk reduction! Greater certainty for business units Better visibility for Management Improved communication with creditors and investors

11 Ways to Estimate Risk Scenarios or Statistics +10% / -10% Standard deviation, Value-at-Risk Market history or Simulations Backtesting Monte Carlo simulations

12 At-Risk can apply to many metrics Name Addresses: Relevant for: Value-at-Risk Market value FX balances Cash Flow-at-Risk Cash flows FX transactions Earnings-at-Risk Earnings or income FX translation Leverage-at-Risk Debt-to-EBITDA Credit ratings

13 What is the cost of hedging? Costs are more challenging to identify Transaction cost (bid/offer spread) Hedge rates versus: Budget rates Spot rates FX Forecasts, market outlook Operational expenses

14 FX balance sheet programs Recent history may be a good indicator of short-term volatility (e.g., 1-month) Market trends, forecasts are less relevant Outliers, tail events are more relevant

15 FX cash flow programs Lack of predictive information on potential longer-term volatility Market trends, forecasts matter a lot! Individual outliers are less important for longer time horizons

16 Balance sheet and cash flow hedging programs Ming Huey Salesforce

17 Balance Sheet and Cash Flow Hedging Programs Describe a typical balance sheet hedging program What does a cash flow program address and what are the elements? Counterparty considerations? Compliance?

18 Evaluating strategies and programs Tony Capozzoli Deutsche Bank

19 Relative Cost Comparing alternatives Lower cost Potential hedging strategies Higher cost Relative risk Lower risk

20 Efficient frontier analysis Adapted for corporate hedging Minimize hedging cost with a risk reduction target Modern Portfolio Theory (Markowitz 1952) Maximize expected return for a targeted level of risk

21 Relative cost Risk reduction versus cost Lower cost Lowest-cost strategy Risk tolerance Inefficient strategies Efficient strategies Higher cost Relative risk Lower risk

22 Applications of the analysis Compare individual strategies Compare the current program to alternative programs Illustrate cost-benefit of the current program by comparing to the unhedged exposures

23 Relative cost Value of the current program Lower cost Cost reduction Current program Unhedged exposures Higher cost Risk reduction Relative risk Lower risk

24 Appendix Tony Capozzoli Deutsche Bank

25 Survey Findings: Value of the Risk Management Function In the risk management section of our CFO survey, we asked CFOs to estimate the fraction of their firm s value that they would attribute to risk management activities. Roughly 40% of participants said that they could not estimate its contribution. Of the survey respondents willing to estimate risk management s contribution to firm value, the average value contribution was judged to be 3.8% of market capitalization, or about 35% of the estimated contribution to value (10.8%, on average) of the total financial management function. Moreover, in those 60% of cases where survey respondents estimated the value added by the finance and risk management functions, the risk management function was judged to produce a decent bang for the buck, contributing a larger fraction of the finance value-add than it consumed of the finance budget. - Servaes, Tamayo & Tufano, The Theory and Practice of Corporate Risk Management, Journal of Applied Corporate Finance, Fall 2009

26 Outliers and tail events Daily change in spot GBP January 2007 to date 95% Confidence 5 th Percentile Outlier ( Black swan ) Brexit Fat tail VaR = 0.9% -8.0% -2.5%-2.0%-1.5%-1.0%-0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5%

27 Lack of predictive information on potential longer-term volatility 16% 14% 12% 10% 8% 6% Volatility Implied Volatility 1-year history 4-year history 4% Volatility measured over the subsequent year 2% Implied volatility, and 1-year history are lagged by 1 year 4-year history is lagged by 4 years 0% Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15

28 Trending markets can greatly exceed Value-at-Risk estimates EUR spot rate history with Value-at-Risk cones centered on forward rates Spot rate history Mean = forward VaR Cone Strong trends with low volatility Market trends and forecasts matter for longer-term risk management! 1.00 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Dec-15

29 Portfolio analysis Diversification among exposures naturally reduces risk Certain hedges might provide less risk reduction to the portfolio than to a single exposure in isolation

30 Diversification among exposures Exposure size Aggregate risk and diversification Diversification reduces risk by 31% CAD 35.1 BRL JPY MXN CAD Individual Risk 100 EUR MXN 32.0 Total Others 42.5 JPY BRL MXN CAD 0 Individual Risk Aggregate Risk Source: Illustrative data, patterned after global sales for the S&P 500 companies

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