1. Managing Financial Risk: Case Study Prof. Ian Giddy New York University Treasury 2000 NYU/GTA

2. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -2 The Exposure Triangle Transactions Exposure Transactions Exposure Translation Exposure Translation Exposure Economic Exposure Economic Exposure

3. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -3 Case Study: Photronics PHOTOMASKS US DOLLARS

4. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -4 Case Study: Photronics Photronics is the world's leading and fastest growing manufacturer of photomasks. Photomasks are high precision quartz plates that contain microscopic images of electronic circuits. A key element and enabling technology in the manufacture of semiconductors, photomasks are used to transfer circuit patterns onto semiconductor wafers during the fabrication of integrated circuits. They are produced in accordance with circuit designs provided by customers at strategically located manufacturing facilities in North America, Europe and Asia.

5. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -5 Photronics’ International Business ”The globalization of the semiconductor industry has created significant growth opportunities beyond Photronics' core market in North America. Customers operating manufacturing facilities in Asia and Europe, as well as North America, are streamlining their equipment and materials procurement processes, relying on fewer and more capable suppliers. “Photronics has made excellent progress in expanding its presence around the world both by acquisitions and by the construction of new facilities. During the year, new facilities were quickly brought to full production in Manchester, England, and Austin, Texas, while additional technological capability was installed in Singapore. These advanced capabilities have elevated our strategic supplier status with many significant customers who are now benefiting from our balanced approach to international expansion and technology investments. “ In Asia, our Singapore facility is benefiting from our customers' utilization of wafer foundries, reflecting the increasing trend of semiconductor manufacturers moving toward a fabless business model. We believe that the number of companies utilizing foundries will increase as they focus on their core strengths—designing semiconductors and product marketing. Such a business model transfers the risk associated with investing capital in production assets, giving the now "fabless" semiconductor company additional flexibility during down cycles, like the one affecting the semiconductor industry today.” From 1998 Annual Report

6. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -6 Case Study: Photronics l The company and its currency exposure l Income, cash flow and translation effects l The economic risks

7. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -7 Photronics’ International Acquisitions ?

8. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -8 Sales and Asset Abroad ?

9. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -9 The Company’s Debt ?

10. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -10 Photronics: Translation Exposure

11. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -11 Translation Policy The Company's subsidiaries in Europe and Singapore maintain their accounts in their respective local currencies. Assets and liabilities of such subsidiaries are translated to U.S. dollars at year-end exchange rates. Income and expenses are translated at average rates of exchange prevailing during the year. Foreign currency translation adjustments are accumulated in a separate component of shareholders' equity. The effects of changes in exchange rates on foreign currency transactions are included in income.

12. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -12 Exposed or Not Exposed?

13. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -13 Exposed or Not Exposed?

14. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -14 Photronics: Cash Flow Exposure

15. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -15 Currency Risk: Economic Exposure Change in the economic value of the firm resulting from unanticipated exchange rate changes. l Booked vs. anticipated transactions l Expected vs. unexpected changes; the "cost of hedging" l Exposure and the parity assumptions: "We are not exposed in the long run" l Currency of denomination vs currency of determination; compet., elasticities, etc.

16. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -16 Economic Exposure l Economic exposure is how the firm’s revenues and costs will respond to exchange rate changes.  Example: Even though Intel invoices German customers in marks, its future revenues may be unaffected by fluctuations in the mark if the currency of determination of prices in the semiconductor business is the dollar or even the yen. l The currency of determination is the currency in which most of the competition prices similar products.

17. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -17 Operational Aspects of Exchange Risk 1.VOLUME EFFECTS (compensate for changes in profit margins) 2.PRICING FLEXIBILITY (change in margins to offset effect of exchange rate change) 3.DIVERSIFICATION of markets for inputs and outputs 4.FLEXIBILITY (ability to shift markets and sources quickly)

18. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -18 Translation vs Economic Exposure Accounting exposure l Exposure = "Exposed" assets - "exposed" liabilities Economic exposure l Exposure = How will an unanticipated exchange rate change affect the cash flows of the firm?  Domestic sales  Exports  Domestic costs  Import costs

19. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -19 A Realistic Approach l Banks versus corporations: To the extent that the firm is like a bank, do bank-style hedging. Match financial assets with liabilities of the same kind. l Seek to identify economic exposure using product cost-and-market analysis, industry competitive analysis, or statistical analysis on the sensitivity of the company’s value to exchange rate changes. l Hedge economic exposure using debt/swaps for long term exposure, short term instruments for uncertain exposure, and options for disaster insurance

20. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -20 Photronics: Economic Exposure n A/R n INVENTORY n PLANT PHOTO- MASKS SOLD IN UK INVOICED IN GBP GBP?

21. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -21 Photronics: Economic Exposure SOLD IN UK INVOICED IN GBP SOLD IN WORLDWIDE MARKET GBP? USD? PHOTO- MASKS n A/R n INVENTORY n PLANT

22. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -22 Photronics: Economic Exposure SOLD IN UK INVOICED IN GBP SOLD IN WORLDWIDE MARKET DETERMINED BY COMPETITION GBP? USD? JPY? PHOTO- MASKS n A/R n INVENTORY n PLANT

23. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -23 Summary: Types of Exposure Transactions Exposure Transactions Exposure Translation Exposure Translation Exposure Economic Exposure Economic Exposure

24. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -24 What Should Photronics Do? l Hedge, or suffer translation gains & losses? l How can its exposure be gauged? l What does FAS 133 imply for a company like this? l What tools should be used?

25. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -25 Which Instrument?

26. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -26 UNDERSTANDING THE EXCHANGE RISK MANAGEMENT PROBLEM n Value of hedging n Goals n Nature of the business UNDERSTANDING THE EXCHANGE RISK MANAGEMENT PROBLEM n Value of hedging n Goals n Nature of the business MEASUREMENT OF EXPOSURE ACCOUNTING TRANSACTION ECONOMIC NATURE OF THE CASH FLOW EXPOSURE: n One-shot? n Linear? n Contingent on exchange rates? n Contingent on other events? NATURE OF THE CASH FLOW EXPOSURE: n One-shot? n Linear? n Contingent on exchange rates? n Contingent on other events? HEDGING METHODS OPERATIONAL FINANCIAL Linear n Forwards n Futures n Debt n Currency swaps Linear n Forwards n Futures n Debt n Currency swaps Exchange-rate contingent n Options n Debt with option features Exchange-rate contingent n Options n Debt with option features Contingent on other events n Event options n Probability-based hedging Contingent on other events n Event options n Probability-based hedging Examples: n Sourcing flexibility n Pricing strategy n Market diversification Examples: n Sourcing flexibility n Pricing strategy n Market diversification A Corporate Foreign Exchange Roadmap

28. n www.stern.nyu.edu

29. www.giddy.org

30. Copyright ©1999 Ian H. Giddy Financial Risk Management: Case Study -30 Ian Giddy Ian H. Giddy NYU Stern School of Business 44 West 4th Street, New York, NY 10012 Tel 212-998-0332; Fax 212-995-4233 ian.giddy@nyu.edu http://www.giddy.org