IFC Manufacturing-Foreign Exchange Hedging Finance 570 Shan Pin Yi Michael Utama Suphakit Sae-Ue Chanunya Pimpla

Agenda Company Background IFC’s Expansion to Mexico Basie Issue and Immediate Issue Cause and Effect Diagram IFC’s Exposure Evaluate IFC’s Portfolio Hedging Instruments Recommendation

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.

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

Key Person Herve Villa IFC’s 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.

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

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.

IFC’s 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).

Basic Issues

Immediate Issues

Cause/Effect diagram

Time Line

Translation Exposure U.S dollar

Transaction Exposure

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

“Obviously was looking at the wrong fundamental” 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

Source: www.x-rates.com

Source: www.x-rates.com

Forward Contract 57.7% Over Hedge in March Total 12.0% Over Hedge

Plain Vanilla Option IFC’s 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.

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.

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.

IFC’s Portfolio

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 corporate’s hedging schedule.

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.

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.

Thank you