PNC Advisory Series The Lifecycle of a Currency Hedge October 19, :00 PM ET

Transcription

1 PNC Advisory Series The Lifecycle of a Currency Hedge October 19, :00 PM ET Aaron: And with that, we are ready to begin today's PNC Advisory Series webinar and it is my pleasure to introduce our moderator for today, Mr. Bob Celata, Managing Director with PNC. And, Bob, with that, I'll turn the floor over to you. Thank you, Aaron, and good afternoon, everyone. Welcome to today's PNC Advisory Series webinar. As Aaron said, I'm Bob Celata, and I manage the bank's foreign exchange group. Many of you have participated in our past webinars and we thank you for your participation. For those of you who have not attended in the past, I wish to reinforce PNC's ongoing commitment to providing information and insights as you will hear in today's webinar. This commitment is reflected in the content we provide on our PNC Ideas website. The address is pnc.com/ideas. The site offers a rich repository of information to help our clients and prospective clients achieve more in their businesses. It includes a range of resources -- brief videos, articles, economic and financial market commentary and, of course, our webinar series like the one you're attending today. After today's session, we'll send each of you an idea with more information on the past webinars. All of the Advisory Series webinars are recorded with replays available on our website at pnc.com/joinus. Also, I want to give you a preview on our next webinar, scheduled for December 14th, from 2 to 3 p.m. The topic will be, "Navigating the New China." You may register at pnc.com/advisoryseries. We're always developing and refining our editorial calendar and we continue to choose topics based on the input we receive from you. So, at the end of today's session, please provide the feedback we need to keep focusing on the right content for you. Whether it's a webinar, an article or an ideas video. We're going to get started with today's event. We've heard that many companies and businesses have turned to the overseas markets for sourcing products or finding new clients. In doing so, these companies are encountering unprecedented levels of volatility in currency exchange rates. Our speakers today, Tom Armes and John Sylvia, plan to take us all through the lifecycle of a currency hedge. Our goal is to convey a clear understanding of the process, steps and best practices associated with hedging. At the end of the presentation, you'll have the time to ask questions through the Q&A panel that Aaron showed us. 1

2 I'm excited to have Tom and John here with us today. So without any further delay, I turn the session over to John. John Sylvia: Thanks, Bob, and good afternoon, everyone, and thanks for joining us. Today's webinar will be focusing on the lifecycle of a currency hedge. This session has been designed to teach you the process of hedging, from start to finish, from identifying foreign currency exposure, the risks associated with such an exposure, to selecting and implementing a hedge and all the steps in between. Specifically, we will spend time understanding the background of foreign exchange, going over the market terminology and conventions, making sure that all of you have the same foundation. We will then illustrate common methods of identifying currency exposure, developing a plan or hedging policy to effectively manage it. After laying the framework for how you manage your exposure, we will walk you through various strategies, giving you the knowledge to evaluate, select and maintain the strategy which accompanies the goals outlined in your policy. So, to begin, let's provide some general background into the foreign exchange market. Foreign exchange is divided into two main areas, payments and hedging. Payments are really the blocking and tackling of foreign exchange. There are two types of payments, outgoing and incoming. An example of an outgoing payment is when a U.S. company is buying goods from an overseas vendor and the vendor requires payment in their local currency. The company needs the ability to purchase the foreign currency and send the currency to an overseas vendor. An example of the second, an incoming payment, occurs when a U.S. company is selling overseas. In order to facilitate the business with companies in other countries, to knock down barriers to entry into those foreign markets, and to make their goods or services more competitive, the U.S. company offers their products in the local currency of the country to which they are selling. However, the U.S. company is a U.S. dollar functional company, meaning they operate in U.S. dollars. As a result, the U.S. company needs to convert the foreign currency into U.S. dollars. This is accomplished by instructing the paying customer to send the foreign currency to their respective bank account. Upon receipt of the currency, the bank will notify the customer that they've received the currency, the currency will then be converted and the proceeds deposited into the customer's account. In addition to facilitating the transaction, advisors typically provide insight on market timing, events and conditions before entering in to the transaction, ensuring that the customer has the most knowledge possible. In terms of execution, it really depends on the customer preference. Online or phone execution is available and really depends on the level of interaction the customer desires. Now, as I said, these are the basic transactions of foreign exchange. However, an obvious concern with both types of payments is that the U.S. dollars fluctuate depending on the exchange rate and for those of us who either pay or offer payment terms farther out into the future, be it 30, 60, 90 days and so on, this risk-- this represents a risk in U.S. dollars which will either be paid or received. 2

3 As such, the U.S. exporter's margin or the U.S. importer's cost of goods sold can and will fluctuate, making budgeting and forecasting challenging. Companies can mitigate the risk of foreign currency fluctuations by hedging their exposure or locking in exchange rate, effectively crystallizing their U.S. dollars payable or receivable. The same way an advisor does with payments, they will work with you, identifying the exposure, defining your hedging objectives, selecting appropriate strategy, document and maintain the hedges as your business evolves. So what exactly is a payment and what exactly is a hedge? Well, a payment is the agreement to buy or sell a specific amount of currency for settlement in two business days, otherwise known as spot value. The one exception, the Canadian dollar-- is the Canadian dollar, which has a market convention of settling in one business day. A hedge, on the other hand, is the agreement to buy or sell a currency for a date in the future beyond two days from trade date, the one exception being the previously mentioned Canadian dollar, which is anything farther than one day into the future. Now that we have some foundation-- we have some foundation in terminology, Tom's going to walk us through the decision-making process of why customers hedge or not hedge and how they come to the appropriate conclusion. Tom? Tom Armes: Thank you, John, and thank you again to everyone for joining us today. Many of the customers that we work with have a tendency to shy away from hedging for one of several reasons and I'm going to discuss why a lot of the companies that we work with don't hedge, but, as Bob previously mentioned, the business world continues to expand and almost every company that we work with has a growth strategy with a heavy focus on international and doing business internationally creates currency risk. So, let's look at some of the reasons why companies don't hedge, the first of which is currency hedging is speculative. Well, this is a commonly held misconception. In fact, currency investing is speculative, but currency hedging is an effort to bring certainty. Currency hedging is a strategy designed to minimize the impact of a forecasted transaction or existing asset liability that will occur in a non-functional currency or can be influenced by a non-functional currency. The second most frequent objection we hear is in the long run currency gains and losses average out. Well, in response to that, I frequently come back to people with a joke and as a student of economics, I quote my favorite economist, Keynes, who said, "In the long run, we're all dead." And I'm going to take a little bit away from the morbidness of that comment and say that the success of your company, as measured by stakeholders, is likely measured on a more frequent basis than, quote/unquote, the long run. So, frequently companies are measured on a monthly, quarterly or annually basis and those currency fluctuations could impact that measurement. Plus, long-term macroeconomic cycles are often uni-directional. In the last 10 years, for example, 3

4 the euro has gone from under 90 cents to over $1.40, which is a move of greater than 50%. The last objection is, we conduct all of our international business in U.S. dollars. This is fairly frequent, especially with companies that might import from the Far East or from Latin America, or from companies that have just started to reach out into the international space. Some companies do this either because of currency restrictions or because of the ease of utilizing the U.S. dollar for all their transactions. However, this puts them at a competitive disadvantage. Consider that almost all international transactions involve a currency exchange. If you are sourcing from China, which many of our customers do, ultimately the dollars you send are converted to yuan or renminbi, meaning your supplier is taking the currency risk. If you are a price taker, which many customers are that are importing from China-- excuse me for a second. If you are a price taker, many of your customers are that are importing from China and you're taking that currency risk off the supplier, you might lose out, because some of your competitors might be willing to pay in local currencies. Also, if you're selling abroad but only pricing in U.S. dollars, it makes your company appear less international and in a strengthening U.S. dollar environment, it makes your products more expensive compared to those sold in local currencies. We've come across those recently in a-- with a customer that we're working with that builds large projects in Europe and they've been bidding on multiple projects and they bid on three recently. And because of the direction of the U.S. dollar that a lot of us have followed, they've lost two of those three because their prices were that much more higher when compared in local currency terms. The companies that do business internationally and do so successfully have an understanding of their currency exposure and manage that exposure effectively. Those companies manage that exposure because currencies are volatile. A few facts I'd like to share with you. On average, currency prices change every 3.4 seconds. I think a lot of us look at the Wall Street Journal or various currency sites and think that it's a very stagnant, when, in fact, it is the most liquid market in the world and those currency prices are ever changing. From a VAR perspective, or value at risk, which a lot of banks and other companies use to measure their exposures, an equally weighted portfolio of currencies of the 10 largest currencies traded, would be a 35% risk. So, for example, if you had $10 million in payables, on an annual basis that are in a variety of currencies other than your functional currency, that $10 million could, potentially, cost you $13.5 million over the course of that year. And the last thing that I'd like you to consider when looking at volatility of the currency market is that the majority of players in the FX market, in fact over 80% of them, are speculative. You've got trading-- hedge fund managers, you've got individuals that are now starting to trade currencies and their desire is to increase the level of volatility whereas you, as a corporate customer, would like for it to be flat. You'd like to be able to say I know the euro is going to be 1.30 from 4

5 now until the end of the year. Or I know the Canadian dollar is going to be 1 from now until the end of the year. But you're a smaller portion of the overall market and, thereby, don't have the influence that the speculators have on the overall FX market. As you can see from this slide, this is a graph of the dollar index, which is a tradeweighted index, over the last five years and the range has been 25%. The overall range in that five-year period has been 25%. So consider that 25% impact on your business. Now here's an example of how that volatility might impact your business. In this example, a U.S. company has entered into a contract to purchase a tractor from a European manufacturer. Let's assume that the U.S. company's goal is to resell that tractor. The contract terms are for half a million euros in 30 days, but the U.S. company is U.S.-dollar functional. So from day one until day 30, the U.S.-dollar company is unsure how much U.S. dollars that EUR 500,000 will cost them. At the end of the month -- and these are actual rates from April of this year -- at the end of the month the exchange rate has moved from to and the U.S. dollar cost of the tractor has moved from $707,900 to $741,100, a difference of $33,200 or 5%. This difference will impact cost of goods sold and could, potentially, depending on the competitive nature of Company A's business or their ability to pass forward the change of price, it could impact their margin. Companies that don't hedge currency risk often put the treasury department or whichever group is in charge of hedging in a lose/lose scenario. This is something that we often discuss when we meet with the treasurer and assistant treasurers of companies, because if gains are created from currency movement, then those gains are often considered artificial, but if there are losses from currency movements, those losses might be considered mismanagement. Slide 11 is the same transaction with the impact of a hedge, in this case a forward contract, which is the simplest form of hedging, and John will discuss that a little later. Company A knows exactly the U.S. dollar cost of this European tractor now with the impact of the hedge and at the completion of the transaction, there's no impact to cost of goods sold and margins due to currency movements. As I like to say often, hedging creates certainty. So, now that you've decided to hedge, I think it's important that we develop some framework within which that hedge to exist. And the first step in developing a hedge policy is to define and identify your exposures. Now, many companies struggle with this. It seems like a daunting task of going out and looking at your sales and your purchases and wherever else money might be flowing internationally and defining your exposures. And one of the ways companies get around that and move up the learning curve very quickly is to establish minimum amounts to be hedged and, thereby, they eliminate the noise surrounding hedging and surrounding their exposures or the immaterial risks from the hedge equation. 5

6 The second step is to define objectives and controls. In order to determine the success of a hedging program, objectives must be set. A commonly used example and a common quote that we see from some of the hedge policies that we work with is that the goal is to minimize the P&L impact created by exchange rate fluctuations. Many people consider the P&L the front page news of a company and, thereby, they don't want currency gains and losses on the front page. As far as controls, many companies struggle with how centralized or decentralized the hedging program should be, with the trend being towards centralization. Companies will also tend to use dual approval as a control, with treasury, accounting or whoever else the interested party is executing the hedge and another layer of management approving them, thereby separating the duties of initiator and confirmer. The third step is to gather enough data information. Another famous quote that I use with a lot of my customers is that a hedge is only as good as the certainty of the underlying transaction. Regular cash flow forecasts from subsidiaries, information flow from sales and purchasing are an important aspect of establishing a hedge policy. The fourth step is to define metrics. Many companies measure the success of their hedging program in relation to the spot market. Well, that's only going to set you up for failure because no matter what any economist says, they never know which direction the currency is going to be. So, the only way to limit that impact is by defining a metric and setting up a thorough hedging program. In fact, best practices are to set a budget or forecast rate and then hedge to those as a benchmark. As part of a successful hedge policy, clearly defined metrics are critical. And the last step in developing a hedge policy is to continually monitor. Successful companies monitor the relationship between the hedge and the underlying transaction and make adjustments to prevent over or under hedging. Also, market conditions may change and there might be a more appropriate hedging strategy. Consider that both situations are very fluid. Your business is fluid. The FX markets are fluid. So, it's important to continually monitor both of those and to make sure that where those two meet you're matching off your underlying transaction and your hedge. Slide 13 addresses a commonly asked question when we're meeting with customers. The two questions I get most frequently are, what's going on in China? and what's everybody else doing? And this slide answers the second of that, which is, what's everybody else doing? As you can see on this slide, this is quotes from 10-Qs of Walmart, Apple, Home Depot and Coca-Cola. This is how some of those major companies express their hedging objectives. Now, as you can see from a 10-Q, the wording is fairly generic, but the message is very clear in that we manage our exposure to currency risk. 6

7 As we discussed previously in establishing a hedge policy, one of the most crucial aspects of effectively hedging is information. The treasury group is typically at the center of this information flow, with sales communicating existing or potential future sales in non-functional currencies, purchasing providing the same information as it relates to sourcing and management communicating any changes in hedge objectives and treasury assisting accounting with hedge assignments and desired accounting treatments. So now that we've established a framework, John will discuss how to choose the right hedging strategy. John? John Sylvia: Thanks. And now that Tom's explained the importance of hedging for obtaining certainty in your international operations, reliable information and shared with you some best practices, let's take a look at how we choose the right hedging strategy. Back on the previously mentioned steps, when the company defines their hedging policy, one of the areas they evaluate is the risk profile of the company. The risk profile is not only used to decide whether or not to hedge, but also when deciding which hedging strategy is the most appropriate. This is because, while we offer several solutions to mitigate foreign currency risk and while all of them are designed to protect the customer from adverse currency movements, they are unique in how they mitigate risk. The hedging strategy also needs to comply with the corporate hedging policy, making sure that the hedges match the underlying exposure and accomplish the objectives set in the policy. It's also necessary to understand that these hedges, with the exception of a vanilla option, which I'll discuss in a few moments, represent obligations and, as such, the customer must be willing and able to meet the commitments represented in the contract. Finally, the company must consider the accounting impact of the hedging strategy. If the company wishes to utilize fair value or cash flow hedging treatments, this will need to be considered as not all hedges qualify for such treatments. Now, let's take a look at some of the different hedging strategies and the differences to be considered when selecting your strategy. And when explaining FX strategies, I like to go back to the two previously mentioned themes -- risk profile and objectives -- as a starring point. If your risk profile is conservative and you're not concerned with upside potential, meaning you're not concerned with what happens if the currency moves in your favor, then one of three strategies may work best for you -- buy and hold, forward contract or a non-deliverable forward. Now, let's start with buy and hold. This is a relatively simple strategy, requiring only the use of a multi-currency account. Now, what is a multi-currency account? It's the-- it's basically an account where you can keep foreign currency until you either send it to an overseas beneficiary or convert it back into U.S. dollars. 7

8 This strategy works well for a customer who has two-way flow, meaning that they pay and receive currency, but at the end of the day the flows do not completely amount to zero. It enables a customer to purchase or sell foreign currency during periods where the currency is favorable. However, it is necessary to remember that such a tool ties up cash from day one, which is a big difference from the other two strategies. A forward contract, on the other hand, still allows you to eliminate-- to isolate currency risk, but it eliminates the need for putting up cash on day one. What exactly is a forward contract? Well, it's the agreement to buy or sell an amount of currency at a specific rate for a specific date in the future. If you remember, back on slide 11, Tom discussed locking in the exchange rate on the same day that the purchase of a European piece of equipment was made. The effect was that when the payable was due the U.S. dollar equivalent was exactly the same as when the purchases was made. This is a great tool for customers buying or selling overseas as they can crystallize the FX rate, prohibiting a U.S. dollar fluctuation in their payable or receivable while, at the same time, keeping cash free for different obligations in their business until payment for the currency is due. It is important to remember that a forward contract is an obligation to exchange one currency for another and, as such, should be only used for known obligations. While this is a good tool for making future payments, customers being paid in foreign currency might have some reservations about locking in a contract to a specific date because, unfortunately, we all don't have control over when exactly we're going to be paid. As a result, a slightly different variation of a forward contract, called a window forward contract, is available. A window forward contract allows the customer to lock in a rate to buy or sell a foreign currency amount for use during a 30-day window. The result is that the customer expecting payment can have the foreign currency delivered at any point within that 30-day window and still receive the agreed-upon rate was executed. These forward contracts are referred to as deliverable forward contracts because at maturity delivery of the foreign currency is made. But what happens when you're dealing in a currency with strict central bank regulations or in a currency where no deliverable forward market exists? Such a situation happens frequently when dealing in many Latin American and Far Eastern currencies. So how do you hedge against currency fluctuations where no forward market exists? The answer is through the use of non- deliverable forwards. What this strategy does, it allows you to lock in a forward rate and at maturity if the currency market rate is more favorable than the hedged rate, you pay your counterparty the difference between the current market and the hedged rate. If the prevailing rate is less favorable, your counterparty pays you the difference. The important thing to remember is that while there will be a U.S. dollar cash flow at maturity, be it an inflow or an outflow, it will be offset by the change in the value of the underlying transaction. 8

9 The strategies we have discussed to this point have been for customers with conservative risk profiles who are only interested in eliminating currency risk. However, for customers who aren't so conservative but are also interested in capturing better than current market rates, the following are just a few available solutions -- vanilla options, participating forwards and range forwards. A vanilla option gives you the right, but not the obligation, to buy or sell a currency at a specific rate at a specific date in the future. It provides 100% protection against unfavorable movements, yet allows for unlimited participation in 100% of favorable market movements. Your strike rate, another name for a protection level, is completely customizable. However, the closer your protection level gets to the actual forward market, the more upfront premium is required to purchase the vanilla option. While unlimited participation in 100% of favorable market movements is attractive, paying out-of-pocket premiums for that rate may not be as attractive. Alternatively, there are ways in which companies can secure downside protection, along with upside potential, without paying out-of-pocket premiums. This is accomplished by using a combination of option strategies. First, let's look at participating forwards. A participating forward provides 100% downside protection, yet it gives you the ability to participate in unlimited upside potential on a portion of your exposure, which is usually about 50%. These structures are typically priced at zero cost because the customer is buying one option and financing the premium of that option by selling another option. Let's use the example of a customer who needs to make a euro payment of EUR 1 million in three months. If they lock in a participating forward at a rate of 1.40, they are completely protected the euro appreciates above Thus, they will never pay more than However, should the euro become weaker and work to the customer's advantage, the customer can participate in 50% of the benefit. Let's put some numbers to it. In the event that, at expiration, the euro finishes at 1.30, the customer will buy half of their euros at 1.40 and the remaining at 1.30, creating an average of When you compare that average rate of 1.35 to the current forward market rate where they could lock in a forward contract at , the 1.35 is much better, and lowers the U.S. dollar equivalent of the U.S. company's payable. The second combination of option strategies designed to have a zero premium is called a range forward. This strategy is similar to a participating forward in that it allows the customer to finance the purchase of one option with the sale of another, except that, like the downside, the upside, too, is limited. Let's go back to our euro payment example. The customer's downside would be capped at 1.41, meaning they would pay no worse than 1.41, but they'd be allowed to participate in 100% of the favorable movements or a depreciation in the euro all the way up to 1.35, at which point their gains would be capped. 9

10 Now that we've presented several different solutions depending upon your risk profile and objectives, you're left with the question, how do you choose and what's best for you? Let's take a look at an example who needs to make a EUR 1 million payment in three months. On this slide, slide 17, we compare the deliverable strategies on one page to help you think about the tradeoffs in a numerical format. Will use the forward contract as a baseline for comparison. As you can see, the forward contract has the most attractive worst-case rate, but the tradeoff is that you give up any potential upside. Now, you're probably saying, wait a second, John, the vanilla option also has a worst-case rate of and the upside's unlimited, so why wouldn't I choose that one? The answer is that when you include the $50,000 premium required to buy the option it takes your true all-in rate, inclusive of premium, up to Conversely, another way to think about it is that the euro would need to depreciate more than for you to be better off doing the option than the forward. For the 50% participating forward, you can think about it in that it has a worstcase rate which is less attractive than the forward contract and the call option, but the difference is that, unlike the call option or the vanilla option, it's zero cost and has a better break-even than the forward contract, compared to the call option. Like the participating forward, the range forward has a worst-case rate less attractive than the forward contract, but it caps your gains at And because you buy 100% of your exposure anywhere between the band of 1.35 and 1.41, your break even when compared to the forward is exactly equal to the forward contract at The following slide graphically illustrates your true rate-- your true all-in rate at expiry. This slide clearly illustrates the risk/reward relationship between these strategies. The outright option, risking the most with the upfront premium, but as the euro weakens or moves in the customer's favor, the effective rate falls the fastest or has the greatest slope. And as you take less and less risk with your strategy, the slope decreases, ending with the forward contract, which essentially has zero slope, because no matter where spot is at maturity you're guaranteed your hedged rate. The final consideration, discussing which solution is best for you depends on your own individual currency outlook. For example, in our example of the customer who needs to make a euro payment, if you believe that the euro is going to appreciate over the next three months, then you do best to just locking in the forward contract. Because there's no point in taking any additional downside risk if you do not believe that the upside is attainable. However, if you do believe that the euro will depreciate over the next three months, then one of the three option strategies may work best for you. Now that we've explained a few different strategies, weighed the considerations and given you enough information to help you make the decision of which strategy works best for you, Tom will walk us through the implementation. Tom? 10

11 Tom Armes: Thank you, John. Well, that was a thorough description of some of the strategies that you can use to hedge your currency risk and I think that the next section of hedge implementation is something that a lot of the companies that we work with have a tendency to skim over and I think it's one of the more important aspects of the lifecycle of a currency hedge. Because once you've determined the strategy which you're going to utilize, it's really time for hedge implementation, but a lot of companies just pick up the phone and do the deal and forget about it. So, I'm going to take you through the steps going from start to finish of a successful or thorough hedge implementation, the first of which is to choose a counterparty. And some important considerations to make when choosing a counterparty are creditworthiness -- in fact, those of you that have had the pleasure of being exposed to FAS-157 know that if you have an asset or a hedge that's in the money on the books with a counterparty, that you have to discount that asset based on the creditworthiness of your counterparty. One of the other portions of choosing a counterparty is the value of the relationship. A lot of companies share their wallet, so to speak, with their various credit providers and-- depending on who they value that relationship. And the last consideration when choosing a counterparty, I think, is to determine whether or not they're a market maker in the currency. This could have an impact on pricing. This could have an impact on delivery and it's very important to discuss with your counterparty what their overall position is in the currency that you're dealing. The second step in hedge implementation is to discuss market conditions. One of the common mistakes that we have a lot of companies mistake is that they decide late afternoon on a Friday that it's a good time to put in a hedge when, in fact, the liquidity from the market is absolutely gone. The best time to actually do hedging is actually early morning during the week when two of the three largest FX trading centers -- those being London and New York -- are online. The third largest FX trading center, by the way, is Tokyo. The third step in hedge implementation is confirming the size and duration. I think a lot of companies get something -- a piece of paper that comes across their desk, a listing of exposure and go straight to their counterparty without verifying that information internally and that creates mismatches between the hedge and between the transaction. So, it's important to confirm the details internally with all the interested parties and then externally confirm those details and communicate your needs to your counterparty so that they can come to you with the best possible solution, similar to what John was discussing a few minutes ago, and really tailor your hedging to your needs. The fourth step is understanding pricing mechanics. Some of the strategies that John discussed require a premium. So it's important to consider cash flows. Also, it's important to understand how the structure is priced and what market factors contribute to that pricing. Forward contracts, for example, are priced by the price market plus or minus the interest rate differential. So, you would think that a forward contract would move 11

12 according to where the euro moves and that, for the most part, is true, but a forward contract in euro also is impacted by interest rates in Europe, Euribor, for example, or interest rates here in the U.S., LIBOR, for example. The fifth step in hedge implementation is indications. This is a step that's skipped very frequently by the customers that we work with. I think it's important to go to your counterparty and ask for an indicative price so that you can evaluate the risk/reward profile, which John talked about earlier, you can get a feel for the market. And a good counterparty is willing to provide you insight into market conditions. They can talk to you about where some other orders might be, what the flow looks like, and give you-- again, give you a feel for the market so you know you're not entering the lion's den. There are certain days where volatility is so high, it's not even worth going out and trying to get a trade done. But if-- in the right conditions, the next step is to lock in the hedge. And it's important to communicate certainty and ask for firm pricing. On the previous step it was indicative pricing or best, you know, what does it look like pricing. This is firm pricing, locking in the hedge, dealable pricing. So it's important to ask for that firm pricing from your counterparty. And also, from your perspective, recognize that you now own the hedge, once committed. And the last step in hedge implementation is understanding the confirmation and settlement procedure. I think a lot of-- again, a lot of companies take this step for granted and they just assume that everyone's going to have the same confirmation and settlement procedures, but it does vary from counterparty to counterparty. Typically, phone confirmations immediately follow trade execution, with paper confirms following shortly thereafter. Sometimes those paper confirms are required to be signed and returned, so it's important to know who's an authorized signer based on the FX documentation that you've entered into with that counterparty. And then settlement could be on trade date or value date, depending on if a credit line has been set up on your behalf with that counterparty. So, again, that impacts cash flow, so it's important to underst and what the settlement procedure will be. So now that we've determined what hedge we're going to do, we've implemented the hedge, the next step is maintaining the hedge. And a lot of-- again, a lot of companies just say, all right, the hedge is done, putting it in the drawer, we're going to forget about it, and they don't actually maintain the hedge. But the companies that do this really well are very dynamic in how they approach the hedging of their currency risk. So, one of the ways-- one of the things that we get requests for a lot is mark-tomarket and mark-to-markets are I can give you a value of your hedge position and are typically shared with your accounting department and are often externally shared with your auditor. So, it's very important information to give you a clear view of what that hedge value is. The second thing in maintaining a hedge is true-ups. Now, as the underlying transaction fluctuates, it's important to add or subtract from the hedge to make sure that you're matching it very closely. 12

13 The third thing in maintenance of the hedge is draw-downs. As John mentioned, there's a hedge strategy called a window for contract and that allows a company to periodically utilize a portion of the hedge. It's important to manage those intermediate cash flows and know the balance of the hedge and the balance due on the transaction. The fourth step in maintaining a hedge is timing issues. Now, we all know that when we get a-- when we're looking at transactions, from sales or from purchasing, and it's six months down the road, that six months isn't really six months. In a lot of cases, that's going to be seventh months or eight months, but we have to enter into the hedge based on what the documentation, the initial documentation says, so companies enter into a six-month hedge based on that information that time. Now, delivery schedules have a tendency to slip, as I mentioned, and so, you can utilize what's called a currency swap and that allows you to adjust the delivery date or roll forward the value date of that hedge. The fifth step is hedging ineffectiveness. If the underlying transaction changes and is significantly different and unlike true-ups where there's little kind of micro corrections, this is more concerned with major differences in the date or the value of the hedge compared to the transaction. It might be prudent to reassign, completely unwind or reduce or increase the hedge, depending on how that underlying transaction plays out. And the last step in maintaining the hedge is accounting treatment. Now, when companies are attempting to qualify for certain accounting treatment, it's important to document and test the hedge for effectiveness. In fact, if you're looking for a specific type of accounting treatment, you have to-- it has to be ongoing documentation, even leading up to the hedge and beyond, and then hedging-- testing that hedge for effectiveness on an ongoing basis through a variety of different types of tests. So, we've gone from start to finish. We've gone from start to finish with hedging on the lifecycle of a currency hedge and we've given you an overview of the lifecycle of that hedge from understanding the market to defining your risk tolerances and objectives through the use of a hedge policy, to execution of the hedge with an appropriate counterparty in a clearly defined manner and finally measurement of the hedge to ensure effectiveness and proper accounting treatment. And the goal of today's session, I think really from your perspective, is to minimize the impact of exchange rates on your business by allowing you to focus on your core business and allowing you to develop a framework within which that hedge exists, to give you the solutions needed or the strategies needed to execute the appropriate hedge for you and then by ongoing maintenance and information flow within your organization. At this point, that concludes the presentation portion of our discussion. Bob, would you like to open it up for questions? 13

14 Yes, Tom, thanks. That was a great presentation and I know that some of our attendees would like to ask some questions. So we're going to move into the question-and-answer part of our session today. We've had a few questions come over the Q&A panel. So, I'll remind everybody that you may use the Q&A panel in the upper middle of your screen to ask a question. We also had some questions submitted as part of the registration process, so I'm going to ask a few of these questions and we'll see how much we can get through. So, first question is for Tom. When should companies start doing FX hedges? What is the rule of thumb in terms of the threshold of exposure that makes hedging a justifiable cost? Tom Armes: Well, it's a great question, Bob, and I think it's something that a lot of companies that we work with struggle with and we talked about it a little bit in one of those slides I covered earlier that said to identify kind of the minimum amount that needed to be hedged. This is usually defined within the hedge policy and it says that, you know, there's a certain-- at a certain point we're going to hedge our exposure in Europe or in Latin America, wherever the case may be. And it really varies from company to company, unfortunately, in that they-- it just depends on their risk tolerance. Companies that have huge margins and are a-- you know, it's an oligopoly or something like that, they have a tendency to hedge less frequently because they're not as exposed, their business isn't as exposed to it. But, as a rule of thumb, what I've seen is that when the critical mass for actually initiating a hedge program and establishing a hedge policy and looking at different strategies is 10% seems to be the magic number of the amount of sales that they have overseas. You know, if it's 10% of their overall sales is overseas, then they start to hedge, then they start to hedge that. Or if it's 10% of their overall sourcing budget comes from overseas in the non-functional currency, then that's the point at which they really start getting interested in hedging. Tom Armes: Thank you, Tom, and as a follow up to that question, I'm seeing a couple questions here online. Is there any minimum dollar amount to hedge in order for it to be economical? No. You know, I think it's really about the time value of doing this the right way, which we talked about, obviously establishing a hedge policy, you know, looking at the various strategies, discussing it with your counterparties and the ongoing maintenance of that hedge, either from-- both from an accounting perspective and a financial perspective. I think that as long as you can justify it within that framework, there's no minimum amount. I mean, as a frequent counterparty to companies doing these hedges, we don't have a minimum amount to hedge, unless it's a very complex product where we have to-- where we have to go in and actually structure something and then we have to look at it from a time value ourselves. But for the most of what John discussed, which are kind of the vanilla structures that we see a lot of companies gravitating towards in this highly compliant environment, there 14

15 is no minimum to hedge. It's really about how much time value you want to put into it. John Sylvia: Great. Thank you, Tom. The second question I'll direct to John. Our customers in Latin America have problems when the dollar gains in value and then our customers delay their payments to us until the exchange rate improves. What can we do to protect ourselves from this? Is this on the customer's side to take precautionary measures? John? Thanks, Bob, and that's a great question that's quite timely, actually, because what we've been seeing in the market, especially over the last couple of months, with all this global economic uncertainty surrounding the European debt crisis and its affect on risk aversion, the emerging market currencies, such as the Latin American currencies, have really suffered as a result. And just an example that comes to mind is Brazil and the Brazilian real and in the month of September, just to give you a frame of reference, it depreciated over 20% in one month, meaning that the goods that Brazilian customers buying from the U.S. became 20% more expensive in a month, without a price increase from that U.S. exporter. So, how do you protect against it? The way to do it is through the use of what I discussed earlier, a non-deliverable hedge, which allows you to lock in the exchange rate at the time the sale is made, the key being to price to your Brazilian real in Brazilian reals and then at the time of payment, presumably a month or two later, sometime into the future, the Brazilian customer is going to send real to the U.S. dollar vendor. And the Brazilian sending bank will convert the dollars into-- will convert the real into dollars and deposit them into the U.S. dollar account. Now, they'll be converting it at the current market rate, which is going to be different than the time when it-- than the exchange rate when the transaction was entered into. The thing to remember is that on the other side of the equation, the U.S. exporter has locked in a non-deliverable hedge, which will compensate the exporter for whatever change in expected dollars is actually realized. The result is that both you and your customer will be indifferent to whatever the exchange rate is at time of payment, eliminating the delay and, as a result, speed up and protect the value of the U.S. dollar receivable. Tom Armes: Great. Thank you, John. Tom, I'm going to direct a question to you that is coming through on the chat window right now and it's related to this best practices/policy. So we're being asked, are there any examples of FX policies that can be made available to clients who are trying to establish a new policy on hedging? Certainly. We present our clients that are just getting into the hedging game, quote/unquote, with a white labeled hedging policy that gives you some reference. Obviously, companies take that and then tailor it to their specific needs, but we're happy to provide that information and that framework to get you started. And it's widely available information. A lot of banks can provide that information, but we have gleaned our white-labeled hedge policy from, you know, all our years of experience with all our multiple counterparties and I think it shows really well. 15

16 So, whoever that person is that's asking that question, feel free to reach out to us directly and we can provide the info. Tom Armes: John Sylvia: That's great. Thank you. You're welcome. John, a question about timing. How far out in the future do most companies hedge. Do they typically just hedge from one fiscal year to the next or do they do it on a rolling basis? To answer that question, I'm going to start by saying it's really all relative. It depends on several factors such as, as Tom had mentioned, the reliability of a company's forecasts, the goals outlined in their hedging policy, even where they see what their own currency outlook is, just to name a few. But to give you a feel for it, we see customers, you know, hedging anywhere from one month to a year and in some instances up to two to three years, depending on the underlying exposure. So it's really a case-by-case basis. And to take that question one step further, in terms of the amounts or percentage hedged, we typically see customers using a layering technique where, for example, they'll hedge 100% of their first quarter exposure, 75% of their second, 50% of their third and 25% of their fourth, the goal being to make sure that their 12-month is always-- that percentage comes out to just over 62% hedged and what that does is also minimize the risk of over-hedging because near-term forecasts are much more accurate than longer-term forecasts. Tom Armes: Great. Thank you, John. I'm going to propose one more question before we start to wrap things up here. And the question has to do with something that, Tom, you had addressed earlier, which is in the selection of a counterparty. So, the question that we received is, who are the typical counterparties in a typical hedge? Is it PNC and the client or are their other parties involved? A great question and very topical, considering all the legislation that's going through right now. Foreign exchange -- most foreign exchange contracts are OTC or over the counter. And what that allows the two parties to do, especially the counterparty to do is to customize it to your needs. Because I think that a lot of the exposures that we've discussed are, you know, it's not a round million dollars every third Friday like something that would settle on a commodity exchange. It's, you know, I need, you know, EUR 2,725,000 on November 15th. And so because of that-- the way those work from an over-the-counter perspective, the two counterparties are usually the corporate customer, the people that, obviously, are tuned into this call, and then the bank. As a market maker in both the spot, forward and option markets, PNC is a frequent counterparty to corporate customers that are looking to hedge their exposure. And so, to answer the question, the two frequent parties within each the interested parties in the hedge transaction are the corporate customer, looking to minimize the impact of some type of asset or liability on their financial statement, and the bank that's willing to make a market in that particular avenue of foreign exchange, whether that be spot, forward or options. Great. Thanks, Tom. 16

17 Tom Armes: No problem. I think we're just about out of time. I wish to thank Tom and John for the time that they've spent preparing for this session and also for delivering such a superb presentation this afternoon. Thank you, Tom and John. And just as importantly, I want to thank each one of you that has attended today. If we didn't get to your question, we're going to make every effort to follow up and get you the answer. Now, just stay with me here for one second, because we do wish to have you participate in a survey for us. In addition to the survey, a PDF of today's presentation, as well as a CTP certification credit will be available for you to download now from the handouts window in the upper right corner of your screen next to the feedback dropdown. So, at the top of your screen you may see an icon that looks like three different pages and you'll be able to download both today's presentation, as well as your certification credit. You'll also see a link on the screen now and we would very much appreciate your feedback and your thoughts about today's session. So this concludes our presentation today and thank you very much for joining us. The materials or video that you are going to view were prepared for general information purposes only and are not intended as legal, tax or accounting advice or as recommendations to engage in any specific transaction, including with respect to any securities of PNC, and do not purport to be comprehensive. Under no circumstances should any information contained in those materials or video be used or considered as an offer or a solicitation of an offer to participate in any particular transaction or strategy. Any reliance upon any such information is solely and exclusively at your own risk. Please consult your own counsel, accountant or other advisor regarding your specific situation. Any opinions expressed in those materials or videos are subject to change without notice. Investment banking and capital markets activities are conducted by PNC through its subsidiaries PNC Bank, National Association, PNC Capital Markets LLC, Red Capital Markets, Inc., and Harris Williams LLC. Services such as public finance advisory services, securities underwriting, and securities sales and trading are provided by PNC Capital Markets LLC and Red Capital Markets, Inc. Merger and acquisition advisory and related services are provided by Harris Williams LLC. PNC Capital Markets LLC, Red Capital Markets, Inc., and Harris Williams LLC are registered broker-dealers and members of FINRA and SIPC. Harris Williams & Co. is the trade name under which Harris Williams LLC conducts its business The PNC Financial Services Group, Inc. All rights reserved. 17