1. copyright anbirts1 Definition of Risk Variability of Possible Returns Or The Chance That The Outcome Will Not Be As Expected

2. copyright anbirts2 Why Manage Risk? Objective of the Organisation Maximise Shareholder Wealth How? Cash Flow = Value Discount Rate - Reduce Volatility - Reduce Risk - Reduce Cost of Capital

3. copyright anbirts3 Variability P & L Seasonality Cash Flow Discount Rate Cost of Capital Equity/Debt CM Effect FX Liquidity Payables/ Receivables Better Rated Lower Cost Trade Credit Tighter Ratios

4. copyright anbirts4 Should We Manage Risk? Perfect Markets Parity Portfolio Theory

5. copyright anbirts5 Risk Management Culture – Focus Identify Categorise Measure Impact Manage Define Accountability Report Policy Risk Management Process

6. copyright anbirts6 Why Identify Risks? Unidentified risks will not be managed Managing risks can improve performance Identification provides information about riskiness Alerts the Organisation to the importance of risk

7. copyright anbirts7 Categorisation Different Ways BusinessFinancial Avoidable Transferable Manageable

8. copyright anbirts8 Financial Risks Price/Market Risk Foreign Exchange Interest Rate Equity/Bonds Commodity

9. copyright anbirts9 Financial Risks Liquidity Cash Flow Opportunity Cost Cash Concentration

10. copyright anbirts10 Financial Risks Credit Default Concentration Systemic

11. copyright anbirts11 Country Risk The likelihood that unexpected events within a host country will influence a clients or a governments ability to repay a loan or make a payment. Sovereign Risk Unilateral repudiation of foreign obligations Economic Risk Inability to Pay

12. copyright anbirts12 Translation Exposure Translation exposure represents the effects, as reflected in the balance sheet and/or profit and loss account, of a movement in exchange rates between reporting dates on the translation of assets and liabilities denominated in foreign currencies.

13. copyright anbirts13 Translation Exposure (In Millions) ASSETSUSD@ 1.20 GBP @ 1.50 GBP LIABILITIESUSD@ 1.20 GBP @ 1.50 GBP Cash151210Creditors due in one year 957963 Investments201713Creditors due over one year 654 Debtors655444Provisions111 Fixed Assets201713Shareholder Funds 181512 1201008012010080

14. copyright anbirts14 Economic Exposure The risk that, long term, the relative appreciation in real terms, of the currency in which a companys major costs are denominated, will adversely affect that companys competitive position.

15. copyright anbirts15 Economic Exposure: An Example CoA Manufacturer in UK selling to France Inflation rate 4% p.a. Current Price GBP 100 Current Exchange Rate EUR/GBP.6503 Competitor in France Inflation Rate2% p.a. Current PriceEUR 153.7752 At Year End If PPP held UK Price GBP 104 (100 x 1.04) French Price EUR 156.85068 (153.7752 x 1.02) Therefore Exchange Rate 104 =.6630509 156.85068 But if rate has moved to EUR/GBP.6300 then UK Price of GBP 104 = EUR 165.08 French price of EUR 156.85 Will they sell any goods?

16. copyright anbirts16 Transaction Exposure The risk that arises from exchange rate changes reflected in the day to day trading activities of a company. TRANSACTION EXPOSURE EXAMPLE Receipt due 180 days USD1,000,000 GBP value @ current spot of 1.44 694,444 GBP value @ current spot of 1.50 666,666 LOSS27,778

17. copyright anbirts17 Interest Rate Risk The risk of loss of interest revenue that occurs when interest rates change, through the mismatch of re-pricing of assets and liabilities.

18. copyright anbirts18 Approaches To Hedging 1.Foreign Exchange –Spot –Forwards –Money Market Hedge –Swaps –Options

19. copyright anbirts19 Illustrations Spot Situation: Receipt of USD 10,000,000 in two business days time Spot RateGBP/USD 1.6356 – 1.6366 Sell USD to Bank, Buy GBP Rate 1.6366 ReceiptGBP 6,110,228.52

20. copyright anbirts20 Illustration Forward Situation: Receipt of USD 10,000,000 in 32 days time Spot Rate GBP/USD 1.6356 – 1.6366 1 month Points97 1 Month Forward Outright1.6347 – 1.6359 Sell USD to Bank one month forward and Buy GBP rate 1.6359 Receipt GBP 6,112,843.08

21. copyright anbirts21 Illustration: Money Market Hedge Spot Rate GBP/USD 1.6356 – 1.6366 1 Month Points 9 – 7 Forward Outright 1.6347 – 1.6359 Interest Rates GBP 5 5/8 – 5 13/32 USD 4 31/32 - 4 27/32 Borrowing Spread ½% Borrow USD @ 4 31/32 + ½ for 30 days = 5.46875% Amount Borrowed 10,000,000 = 9,954,634 1 + (.0546875 x 30/360 ) Spot USD 9,954,634 to GBP at 1.6366 = GBP 6,082,509 Invest GBP 6,082,509 at 5 13/32 (5.40625) = 6,082,509 x.0540625 x 30/365 = GBP 27,028 = Total GBP at Day 32 = 6,109,537 Situation: Receipt of USD 10,000,000 in 32 days time

22. copyright anbirts22 Illustration: Swap A Swap is a pure time operation which involves two way flows. In Foreign Exchange terms it is a simultaneous spot and forward. It will be priced off the forward transaction but use the same spot. Example:Receiving Spot USD 10,000,000 Paying Away in 32 Days USD 10,000,000 Spot GBP/USD 1.6356 – 1.6366 1 Month Points 9 7 1 Month Forward 1.6347 1.6359

23. copyright anbirts23 Illustration: Swap Spot Sell USD 10,000,000 at 1.6356 Buy GBP 6,113,964 In Forward Buy USD 10,000,000 at 1.6347 Sell GBP 6,117,330