Shan Pin Yi

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Finance 570
IFC Manufacturing-Foreign Exchange Hedging

• Shan Pin Yi
• Michael Utama
• Suphakit Sae-Ue
• Chanunya Pimpla

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Agenda

• Company Background
• IFCs Expansion to Mexico
• Basie Issue and Immediate Issue
• Cause and Effect Diagram
• IFCs Exposure
• Evaluate IFCs Portfolio Hedging Instruments
• Recommendation

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Company Background

• Canadian based company.
• Specialized in producing the parts used in the
  production of automobiles in North American.
• Seatbelt.
• Airbag.
• Two Significant Trends of IFC
• Increased use of outsourcing in North American
  automobile manufacturing.
• Focusing on automobile safety invention.

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Company Background

• IFCs operation based upon the implementation of
  proprietary technology.
• No American plants owned before 1997.
• All U.S. acquisitions took place in 1997.
• IFCs acquisition strategy is based on large and
  efficiency scale that are result of the
  proprietary technology.

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Key Person

• Herve Villa
• IFCs founder and CEO.
• Ph.D in mechanical engineering.
• Entrepreneur profile and hand off owner.
• Got contracts with Big Three car companies
• GM, Ford, and Chrysler.
• Construct production facility in Mexico.

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Key Person

• John Trudel
• Former treasurer and CFO.
• Expert in using financial derivatives.
• Often, Guest speaker at the Treasury Management
  Association of Canadas regional meetings.
• Had free hand in the choice of hedging
  structure.
• Quit IFC in July 1997.

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Key Person

• Bob Young
• Present treasury and CFO.
• Joined IFC in November 1997.
• Worked at Treasury department for 15 years.
• Expert in accounting role.
• However, had no experience in aspect of new job
  at IFC.

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IFCs Expansion to Mexico

• Financial crisis of Asian Foreign exchange market
  and equity markets
• Spread to other developing countries quickly.
• Weaken Mexican peso position against to Canadian
  Dollars.
• IFC wants to build the plant in Mexico.
• Need to get financing from the Manufacture Bank
  of New York.
• Proposed value 826,000,000 mexican pesos (MXP).

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Basic Issues
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Immediate Issues
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Cause/Effect diagram
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Time Line
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Translation Exposure

• U.S dollar

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Transaction Exposure
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Hedging Instruments

• Forward contract
• Plain Vanilla Options
• Exotic Options
• Single Barrier Options
• Double Barrier Options
• Average Rate Options
• Range Binary Options
• Swing Forward Options

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In 1996, Speculators were looking for Cdn 1.3000
per U.S. Dollar and below.
Asian foreign exchange and equity markets melted
down Crisis occurred in the summer of 1997.
Obviously was looking at the wrong fundamental
Trudel left the company in July 1997.
Source www.x-rates.com
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Source www.x-rates.com
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Source www.x-rates.com
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Forward Contract

• 57.7 Over Hedge in March
• Total 12.0 Over Hedge

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Plain Vanilla Option

• IFCs transaction exposure is long position.
• IFC purchased Canada Call.
• Gave them the right to sell U.S dollar and buy
  Canadian dollars at the strike price 1.40.

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Range Binary

• A double barrier binary option with knock-in and
  knock-out triggers.
• Binary option in which the payout is all or
  nothing.
• IFC would get 10 million if and only if neither
  foreign exchange rates of 1.3750 nor 1.4750 trade
  before the end of March 1998.
• Premium US 1.47 million.
• Fact Neither rates did trade.
• Result IFC got US 10 million.

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Swing Forward

• Zero cost at inception.
• Combination of buying a call and selling a put or
  buying a put and selling a call at the same
  strike price.
• Contains single barrier knock-in written option.

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IFCs Portfolio
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Evaluation

• Over-hedge translation exposure.
• Exotic options seem to be speculation.
• Lack of internal controls.
• Lack of financial risk measurement program such
  as Value at risk (VaR).
• Lack of efficient computer system.
• Similar to a hedge fund trading portfolio more
  than a corporates hedging schedule.

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Recommendation

• Implement Value-at-Risk measurement.
• Invest in advanced computer systems.
• Do not over-hedging.
• Predictable event, use forward contract.
• Unpredictable event, use option.
• Combine hedging strategy.

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Recommendation

• Develop clear risk management policy.
• Specify a detailed risk management philosophy
  with procedures and controls.
• Use of derivatives should consistent with overall
  risk management and capital policy approved by
  board of directors and senior management.
• Risk limit policies and monitor of transactions.
• Disclose information about their use of
  derivatives.

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Thank you