Day 5 as New Corporate Treasury

Fellow CFAs and CFA aspirants…I need your smart opinion: I have a tough assignment from the CFO on my first week of joining a Global real estate company. Here is the business model of the company: The company’s functional currency is USD and it basically do equity advances for real estate deals to corporate clients in four different currencies: Euro, SGD, CAD & Pound. The clients will at a later stage return the funds plus agreed interest but there is uncertainity regarding timing of receiving these funds in their respective currencies. Now my assignement is to come out with the model: 1. To measure FX exposure (G/)on an ongoing basis 2. To devise the best mechanism to hedge currency risk for such transactions. Thought of multi-notional currency pooling but damn…the mechanics are soo technical

It looks the primary uncertainty has to do with the timing of foreign cash flows, so you probably have to make some sort of assumption about this. Once this is done, you just need to discount the future payouts at the respective country discount rates. This gives you the value of the asset/liability in foreign currency, which you can convert to USD at the current spot rates. Note that you will have some exposure to foreign interest rates, in addition to spot FX rates. You can alternatively look at this as exposure to forward FX rate curves, for instance, risk from 1-year EUR, risk from 2-year EUR, etc. As for hedging… it’s relatively easy to trade forwards up to 2 years to reduce your exposure. For longer maturities, the market is pretty illiquid, so you might have to come up with some creative solution to minimize hedging costs.

Also, in case you have long-dated risk, I would assume that there is a liquid market for foreign interest rate swaps. I don’t have experience with these though.

How much “uncertainty” are we talking about with regard to the timing?

Normally the receivables are coming in between 3-6 months…

Eh, in that case, just trade some forwards at the expected payment maturities. All the currencies you named are super liquid. And even if you’re off by a few weeks, it probably won’t matter. As an example, let’s say you will receive 1 million CAD in 2-3 months. Just assume 2.5 months (or make some other intelligent assumption). Then enter a forward contract to sell 1 million CAD in 2.5 months. If you have many deals and it’s not practical to hedge them individually, just bucket them as 1 month to 1.5 months, 1.5 months to 2 months, etc. Then hedge the bucket maturity.

Ohai, your judgement sound theoretically intriquing but the actual hands on process of turning this into a spreadsheet model for ongoing tracking is surely not easy my friend…This may core for numerous discount rates i guess? Maybe for unrealised G/L tracking I will just track daily spot rates and compare with historical rate? For hedging hmm well will resort to Cash pooling just for liquidity efficiency

It’s actually pretty easy to put this in a spreadsheet, other than the cash flow assumption, that is. I do this as part of my job, only with options, not real estate payments, and with more layers of complexity. You can even do it without looking at interest rates at all, depending on how you plan to hedge the risk. Edit: Ok. I guess you need the foreign interest rates for unrealized PnL calculations. However, you don’t necessarily need to know these interest rates for hedging, provided that you can see the forward prices.

break out level II material and go from there