Currency fluctuations and interest rate risk. Hedging tools in risk management. Adriana Wegemund Anna Kubik Valerie Kobera.

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Presentation transcript:

Currency fluctuations and interest rate risk. Hedging tools in risk management. Adriana Wegemund Anna Kubik Valerie Kobera

Complications faced when investing abroad:  Decisions are made in the conditions of volatility and uncertainity,  Business operating within rapidly changing risk factors, SMART INVESTING INCLUDES RISK MANAGEMENT

Risk factors Changes of currency exchange rate Changes of interest rate CHANGES IN: revenues, cash flows,liquidity, investment opportunities, profits & losses, import & export conditions. decrease & increase of the cost level Changes of inflation rate

Currency risk Foreign currency markets are deep and highly liquid  A key difference between investing in domestic and foreign assets is that the latter exposes the investor to a currency risk  A form of risk that arises from the change in price of one currency (depreciation, appreciation) against another if the domestic currency has weakened (strengthened) against the foreign currency, the exposure would result in a gain (loss)

EUR/PLN (NBP) source:

Example: U.S. based company selling widgets in Germany Source:

Hedge tools – guard against currency exchange risk Insurance policies, forward contracts, swaps and options: Help in minimizing exposure to such a business risk, Neutralizes impact of currency changes on future cash flows, Investment trick to eliminate losses. Designed to have an inverse relationship with the currency exchange impact

Example of future contract impact: Source:

Interest rate risk: Risk that the relative value of an interest- bearing asset, such as a loan or a bond, will worsen due to an interest rate increase. Such changes usually affect securities inversely. Interest rate risks can be hedged by using fixed income instruments or interest rate swaps.

Example: The Company [JCI] had two interest rate swaps outstanding, designated as a hedge of the fair value of a portion of fixed-rate bonds. The change in fair value of the swaps exactly offsets the change in fair value of the hedged debt, with no net impact on earnings.

Before enetering the swap, company was paying variable interest rate on bonds… Source:

… after introducing the swap, company gained fixed rate of interest. source:

To hedge or not to hedge? Arguments in favour of hedging Arguments against hedging  How long is the long- run?  Realized vs. Expected returns  Risk return trade-off  Uncorrelated risks  Expected returns are zero

Sources:  International Financial Management, A. Shapiro,  ‘Financial Management. Principles and Applications’, A. Keown, J. Martin, J. Petty, D. Scott,  Examples from  

Thank you for your attention !!!