Introduction to Currency Risk

Stanley Myint and Fabrice Famery

Contents

Foreword

Introduction

1.

Theory and Practice of Corporate Risk Management

2.

Theory and Practice of Optimal Capital Structure

3.

Introduction to Funding and Capital Structure

4.

How to Obtain a Credit Rating

5.

Refinancing Risk and Optimal Debt Maturity

6.

Optimal Cash Position

7.

Optimal Leverage

8.

Introduction to Interest Rate and Inflation Risks

9.

How to Develop an Interest Rate Risk Management Policy

10.

How to Improve Your Fixed-Floating Mix and Duration

11.

Interest Rates: The Most Efficient Hedging Product

12.

Do You Need Inflation-linked Debt?

13.

Prehedging Interest Rate Risk

14.

Pension Fund Asset and Liability Management

15.

Introduction to Currency Risk

16.

How to Develop Currency Risk Management Policy

17.

Translation or Transaction: Netting Currency Risks

18.

Early Warning Signals

19.

How to Hedge High Carry Currencies

20.

Currency Risk on Covenants

21.

Optimal Currency Composition of Debt 1: Protect Book Value

22.

Optimal Currency Composition of Debt 2: Protect Leverage

23.

Cyclicality of Currencies and Use of Options to Manage Credit Utilisation

24.

Managing the Depegging Risk

25.

Currency Risk in Luxury Goods

26.

Introduction to Credit Risk

27.

Counterparty Risk Methodology

28.

Counterparty Risk Protection

29.

Optimal Deposit Composition

30.

Prehedging Credit Risk

31.

xVA Optimisation

32.

Introduction to M&A-related Risks

33.

Risk Management for M&A

34.

Deal-contingent Hedging

35.

Introduction to Commodity Risk

36.

Managing Commodity-linked Revenues and Currency Risk

37.

Managing Commodity-linked Costs and Currency Risk

38.

Commodity Input and Resulting Currency Risk

39.

Offsetting Carbon Emissions

40.

Introduction to Equity Risk

41.

Hedging Dilution Risk

42.

Hedging Deferred Compensation

43.

Stake-building

Foreign exchange (FX) is the primary corporate hedging activity, whether in terms of the number of transactions, volume or human capital and other resources devoted to it. The reason for this is simple: some companies may elect not to hedge their interest rate risk because its size is not material (for instance, a low-leverage corporate). However, we have never come across a corporation with foreign exposure that doesn’t deal with its currency risk. Basically, FX affects all aspects of corporate financials: cashflow, earnings, assets and liabilities. Therefore, FX influences all key performance indicators, from profitability to creditworthiness. The degree of importance of FX risk management also varies across sectors, from tactical to strategic – it depends on the company’s ability to pass the currency variation to suppliers or customers, and if it can do so better than its competitors.

Key features impacting the FX risk are the length of the production cycle, and the mismatch between the currency of sales, cost of sales and debt. Whatever the nature or consequence of FX risk, a corporate hedging policy has the same goal across all industrial sectors: to support the business by

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