Cash Management

New Currents in Currency

It's relatively simple to hedge foreign-currency risk — if you can figure out your exposure.
Randy MyersDecember 1, 2006

In the second quarter of this year, Weatherford International Ltd.,
a $4.3 billion provider of oil and gas
drilling equipment and services, sustained
nearly $9.9 million in foreign-currency
losses. In the very next quarter, its foreign-currency losses shrank by almost 90
percent, to just $1.5 million. That’s good
news for a company that is keen to, as
senior vice president of finance and CFO
Andrew Becnel says, “remove the noise of
foreign-exchange fluctuations from the
income statement.”

For many companies, that noise can be
grating in the extreme. Four Seasons
Hotels and Resorts would have seen its net
income rise 24 percent over the previous
fiscal year if it weren’t for currency fluctuations;
instead, it posted a 42 percent decline. Given
that the S&P 500 derived more than 40 percent of its
income from overseas sales in 2005, plenty of companies
face similar risks.

Exposure Time

While currency options and currency forwards are
useful tools for hedging (see “Opting for Options” at the end of this article), the true challenge lies not so much in deciding how to hedge as in deciding how much. Determining
exposure can be a time-consuming and frustrating
exercise because companies often funnel data
from various departments, such as treasury, tax, forecasting,
and the controller’s office to a foreign-exchange
(FX) specialist, who then tries to aggregate
those pieces into an accurate whole. “To make sure
you’re hedging the right number,” says Beau Damon,
managing director of capital markets for Microsoft
Corp., “you have to get input from the accounting
group, the business units, and the folks who are forecasting
and planning revenues.” Because most companies
rely on manual processes, that level of collaboration
is difficult to achieve.

Manual processes also diminish visibility:
if one subsidiary has revenue in
pounds sterling, for example, and another
has expenses in the same currency, those
two positions can effectively create a natural
hedge. But often companies fail to
spot such situations and end up hedging
the wrong amount.

Better technology may help. For the
past year and a half, for example, Weatherford
has been working with a large
multinational bank to develop a software
module designed to help Weatherford
manage its FX exposure. The software,
which has been up and running in test
mode for several months and is scheduled
to go live in early 2007, taps into the company’s
various enterprise systems, pulls
out the data that Weatherford has found
most critical to calculating its foreign-currency
exposure (such as balance-sheet
entries for cash and cash equivalents, and
accounts receivable/payable in more than
100 countries), and presents that data in
an easily digestible format on a nearly
real-time basis. From there, Weatherford
can figure out the best ways to hedge its
foreign-currency exposure. “The key to it
all,” says Becnel, “is measurement, measurement,

Holistic Fix

FireApps, a subsidiary of Rim-Tec Inc., a
financial risk-management firm, has developed
Web-hosted software that helps companies
better collect, aggregate, and analyze
their foreign-currency risk by querying
their information systems for relevant data
and performing the analytics needed to
devise hedging strategies. The software
doesn’t simply mirror what’s in the general
ledger, explains Rim-Tec CEO Wolfgang
Koester, but instead presents data in a format
that allows users to easily spot exceptions
or mistakes and either account for or
correct them — particularly in the area of
intercompany transactions. The goal, says
the firm, is to approach currency management
as a holistic process that addresses
strategy, exposure management and analytics,
and transaction execution (using the
firm’s software and consulting services).

If companies suddenly find themselves
able to shop among competing software
companies for helpful products, more of
them may hedge their FX exposure. Today, estimates Jeffrey Wallace, managing
partner of consulting firm Greenwich
Treasury Advisors LLC, only 75 percent of
large companies that have FX risk do anything
to hedge it. Smaller firms are even
less likely to do so, for a variety of reasons:
because the amount at risk isn’t material,
because the CFO or treasurer doesn’t have
the time or staff to focus on it, or because
the management team simply doesn’t
believe hedging adds value.

The latter argument is flawed, according
to New York University finance professor
Ian Giddy, who says that “foreign-exchange
risk does not even out in a given
time period. Some companies are concerned
about the cost of hedging, but
done correctly, the cost is minimal and
the effort is worthwhile.”

Brent Callinicos, who helped launch
Microsoft’s FX hedging program in 1994
and now serves as corporate vice president
and CFO of the company’s platforms
and services division, says the matter is
anything but academic. “Shareholders
and analysts don’t give you a pass for saying,
‘We would have made our earnings
but for foreign exchange.’ Many studies
indicate that shareholders punish that.”

Rim-Tec CEO Koester says software
can highlight potential currency problems
before they occur and help companies
make better decisions. “And you can do it
much more frequently,” he says. “Corporations
today have a hard time accumulating
this data and really understanding it
because by the time they assemble it in a
spreadsheet, the underlying figures have
already changed.” FireApps software is sold
on an annual subscription basis, from
$90,000 to well into the six figures,
depending on scope and complexity.

Randy Myers is a contributing editor of CFO.

Opting for Options

CFOs and treasurers who want to hedge their company’s
exposure to foreign-currency risk have two principal
weapons in their arsenals: currency forwards and currency
options. While CFOs sometimes regard currency options as
too pricey and forwards as virtually free, neither approach
is as extreme as that. Forwards are costless only in the sense that companies pay
nothing for them up front: they simply enter into an agreement to buy or sell a specified
quantity of a currency at a specified price on a specified future date. (Options, by
contrast, require the payment of a premium in exchange for the right to buy or sell a
currency at a specified price on or before a specified date.)

But Jeffrey Wallace, managing partner of consulting firm Greenwich Treasury
Advisors LLC, argues that forwards can become expensive when the market moves
against you. Say that, in a bid to hedge against a declining dollar, you lock in a forward
contract to convert €100 million to dollars at a rate of $1.25 per euro. That would
guarantee you $125 million in the exchange. Now assume the dollar actually rises to
$1.15 per euro; you’ve forfeited $15 million. With an option, the most you can lose is
the premium you paid for the contract — perhaps 1 percent or so on a one-year,
near-the-money option, or just over 2 percent on a one-year, at-the-money option.

Like other sophisticated hedgers, Microsoft uses a mixture of options with differing
maturity dates going out as far as three years, though its portfolio is usually
more heavily weighted toward cheaper, shorter-term instruments. Beau Damon, managing
director for capital markets, concedes that a company might legitimately
eschew options as a hedging tool if it wants to devote its cash flow for other, more
pressing needs, but adds that “in the long run there is no free lunch. Options are priced
as they are for a reason, and they probably have about the same expected returns as
forwards do over the long term.” — R.M.