International Finance

International Finance Assignment

 

Introduction

Every business endeavor or venture is constantly faced with financial management problems to which the owner or manager should be able to attend to in order to take the business to success. Key financial decisions normally confronts the managers in issues and problems that concerns financial investments they usually provide answer to the problems regarding the assets on which the company of firm needs to put money and how a chosen investment should be financed.

All the plans of the company will be put to waste if the organization has no effective system of financial control that will monitor the investment that it ventures on. If outputs are expected, there should be immediate application of the advantages that the organization gained. This will provide the black and white transparency which the company can study to serve as guide in the future investment as well as the management plans and strategies that it will employ.

As the nature of financial management becomes more and more complex in this information and efficient communication era of international business, finance managers face a wide array of challenges, opportunities and options to enhance the investing and financing activities of the organization as well as to minimize the inherent risks and circumstances of the financial decisions that will be made. The challenge now for the financial mangers is to explore the options and take advantage of the opportunities while taking caution in managing the risks. Financial management was defined by  (1999) as the determination, acquisition, allocation and utilization of financial resources with the aim of achieving a particular goal. It consist of analyzing the financial situations, making financial decisions, setting financial objectives, formulating financial plans and providing a system of effective financial control to ensure the progress of the plans towards the attainment of the company aims and objectives. All these are supervised by the financial manager or treasurer in the process of financial management.

“Experiences differ and common usage lack precision” (1988) with regard to risk. Risk involves both hazards and opportunities to people who undertake the risk. People evaluate results based on their evaluation of the situation based as guided by criteria of gains and losses. Furthermore, risk involves trade-offs in which there are some groups who may experience losses in exchange to others goals to profit. The trade-off influences the perception of people about the risk. Oftentimes, the risk issue revolves not on the scientific facts about the risks but the conflict of values and the acceptability of the risk of different groups with conflicting interests.

Foreign exchange risk is commonly defined as the additional variability experienced by a multinational corporation in its worldwide consolidated earnings that results from unexpected currency fluctuations.  It is generally understood that this considerable earnings variability can be eliminated partially or fully at a cost the cost of Foreign Exchange Risk (1981). As a consequence of the increasing economic interdependence in the world, international financial markets have become one of the most important external factors for companies. Especially for import-and export-oriented enterprises, foreign exchange, inflation and interest rates as well as their volatility are crucial for success.

           

 

Kudelski Group Company Profile

For more than 50 years, the Kudelski Group has been the leading technology pioneer in terms of security applications requiring access control and rights management in terms of information exchange in digital television, broadband Internet, and video on demand among others, as well as the control and physical access to sites and events. Company development and growth is highly dependent on technological innovations in providing convenient, high quality and inexpensive access to the services and features of the products they offer through continuous commitment and competence to research

Kudelski Group was founded in 1951 in Cheseux-sur-Lausanne where its headquarters are located along with the organizations subsidiaries in USA, Germany, Austria, UK, France, Brazil, Spain, china, Singapore, Italy, the Netherlands, and Sweden employing 40-60% of the total 1,200 personnel abroad.  The company’s stock is listed on the Swiss Market Index since 1986 as well as on the Morgan Stanley Capital Index whose principal stockholders are the members of the Kudelski family with 34% of the capital and 64%voting rights. The major markets of the company are located in USA and in Germany that avail Conditional Access to Systems (CAS) and the Physical Access products while its suppliers are located in Asia and Europe ( 2003). 

More than 80% of the company’s revenues and 40-60% of the expenditures are exposed to foreign currency exchange risks which are denominated in different currencies in Europe, North America, Asian, Australia, and Africa as well as in Latin America. The crisis in the Digital TV market in Europe and the unpredicted depreciation of the US dollar resulted to negative impacts to the company in 2002 until the 2nd quarter of 2003 mainly because the company’s business in US and Asia generally use the US dollar currency. In response to these US dollar revenue problems, the Group decided to intensify instead its presence in the European market, thus reducing the dependency on the US dollar at the same time minimized the costs incurred in this particular currency. However, Kudelski did not opt to transfer its costs incurred from major European suppliers since they expected the likelihood of US dollar appreciation. As such, the company has been successful in initiating this financial restructuring strategy without the need to utilize external hedging methods which are expensive (2003).

This paper presents the case of Kudelski Group in its objective to incorporate the risks confronting the company into the organizations corporate strategy so as to maneuver the business into attaining its set goals and standards as a member of the international industry in the midst of its foreign exchange risk exposures. The exposure risks being faced by Kudelski Group were enumerated and analyzed to provide a comprehensive understanding of the economic considerations of the company. Recommendations of the company’s exposure and how it will hedge such exposure were likewise presented. 

 

Kudelski Group Exchange Rate Exposures

In order to minimize the foreign exchange risks, one has to know what the risks are.  According to (1998) there are different types of risks that have to be distinguished depending on the type of exposure. These include risks in the transaction, economic and translation exposures of the company.

Transaction exposure risks originates when cash flows have to be changed into another currency. These risks are easy to identify since they have an immediate influence on profitability and liquidity, thus the management usually devotes a lot of attention to the inherent risks of this particular exchange rate exposure (1998). 

Meanwhile, economic exposure risks include all the changes in market share, profit margins, etc. that are caused by exchange rate fluctuations. Often these risks are not visible at first but the consequences are very severe because this exposure measures the change in the present value of the firm resulting from any change in its future cash flows due to unpredicted changes in the foreign exchange rates (1998). 

Lastly, translation exposure risks arise when putting together the company’s financial concerns in the balance sheet in the form of profit and loss statement in which all assets and liabilities of the firm which are denominated in foreign currencies of the company have to be translated. Independent of the different methods, the result of the translation will differ from year to year according to changes in the exchange rates ( 1998).

Since Kudelski Group is actively operating its business in the international market arena, the organization is normally affected with fluctuations of the currency exchanges, particularly those that were not predicted by the management. As such, the company is exposed to all the enumerated and defined foreign exchange risks. However, the company does not manage all these foreign exposure risks due to defined management policies as well as differing company prioritization. The most significant factor that influences and dictates the company’s hedging considerations is the risk aversion discretion of the Kudelski family being the biggest company stockholder, particularly that of Andre Kudelski who holds 7% of the shares as the founder and the current Chairman of the Board, President and the Chief Executive Officer of the firm. Other factors such as industry success factors like trade volumes, geographical markets, market power, and treasurer’s opinion among others dictates the hedging considerations of multinational business organizations ( 2003).   

In the case of Kudelski Group, minute details of the resources of company are monitored for possible lucrative financial endeavors since the company is sensitive with ventures that will promote growth and development of the organization as an international business enterprise. According to the case study conducted by  (2003) which focused on the foreign exchange risk management practices of two medium-sized and non-financial Swiss companies, Kudelski Group prefers short-term (90 days or less) and practices limited foreign exchange risk hedging in order to protect margins. The company hedges 80% of its foreign revenues as influenced by the direct interest of the founder and President of the company.

Moreover, the Group manages its transaction and translation foreign exchange exposure risks through a mixed centralized and non-centralized treasury operations in which measured subsidiary exposures are collected for the overall company exchange rate exposure report and conceptualization of management policies. The company considers transaction exposure risks as the most important which is measured every month while translation exposure risks are only measured sometimes. Economic exposure risks are ignored by the firm (2003).

 

Kudelski Groups’ Theoretical and Practical Exposure Risk Management Considerations

The general concept of exchange rate exposure refers to the degree to which the value of a firm or an industry is affected by exchange rate changes.  Exchange rate changes can affect an individual investor who owns a portfolio consisting of securities in different currencies; a multinational company with subsidiaries and braches in foreign locations; an exporter and importer who concentrates on international trade and even a firm that has no direct international activities.  Furthermore, exchange rate changes, through their impact on the costs of inputs, outputs, and substitute goods play a significant role in determining the competitive position of domestic companies with no direct international operations relative to foreign firms ( 2002).

Often it is argued that billing in the domestic currency does not involve exchange rate risks. However, this is only partially true because although there is no transaction risk because foreign currency need not be changed, there are still existing market risks (1990). In this light, foreign exchange rates affect every walk of life, not just financial markets although exchange rate movement can be significant for companies engaged in international trade, exposed to revenues and costs in foreign currency, or competing with foreign firms. For Kudeleski Group to emerge successful, the management is sensitive to practical and theoretical issues that the business organization address as influenced by its economic situation in the industry and environment in the structure and management policies of the firm. Taking into account these considerations are deemed helpful in minimizing the exposure risks that the Group faces in its international business operations and transactions.

In line with the financial theory, any change in an exchange rate should affect the value of a firm or an industry (1978).  Exposure risk of Kudelski Group is extensive since its business endeavors deal with international business operations as evident in the company’s several subsidiaries all over the world. As such, rate changes in the different currency denominations that fuel the company’s international market activities render the group to possibilities of increased or lowered value of the organization.  However, modern principles of the theory of finance suggest prima facie that the management of corporate foreign exchange exposure may neither be an important nor a legitimate concern. It has been argued, in the tradition of the  Theorem, that the firm cannot improve shareholder value by financial manipulations: specifically, investors themselves can hedge corporate exchange exposure by taking out forward contracts in accordance with their ownership in a firm (1978).

Several studies have presented their arguments regarding the relevance of practicing foreign exchange risk exposure management.  (1958) claimed that corporate financing policy is irrelevant, particularly hedging policies withy no transaction costs and taxes since investors can readily change their risky holdings. This was supported by Logue and Sweeney (1977) stating that translation exposures has only accounting benefits and that the currencies’ instantaneous adjustments to inflation leaves no effect on the true economic value of the firm. But  (2003) claimed otherwise by providing explanation on the importance of hedging practices among multinational companies due to business considerations of companies which include taxes, financial distress, manager’s risk aversion, agency costs, investment policy, transaction costs, and signaling managerial skill. 

In the case of Kudelski Group transaction exposure risks are hedged by company primarily to protect margins and are considered as the most relevant foreign exchange risk management approach. This is contrary to theoretical claims of financial literatures which claimed that economic exposures (which the Group ignores) should be given primary consideration which affect the current obligations of the firm as well as the company’s future economic value (2001). Although, management claims often does not give translation exposure risks the necessary attention because it is argued that these changes are just book changes and not real changes despite its significant influence to the equity basis and the profit and loss statement concerns of the company (1995), Kudelski’s use of translation exposure risk management is generated by the interest of the Chief executive Officer of the Group as the most influential management entity and at the same time the biggest shareholder of the organization. 

 

Kudelski Group’s Hedging Tools and Techniques

Many companies view foreign exchange risk as an important risk, however they differ in organizing and managing (2001; 1998; 1981). According to (1998) one explanation of the crisis in foreign exchange markets is that a large proportion of foreign borrowing by corporate and banks was unhedged because of prevailing expectations of stable exchange rates. When these expectations were disappointed, they scramble to repay these foreign currency loans created a massive market imbalance and a collapse of the foreign exchanges. The foreign exchange risk really creates a big impact to multinational companies due to the impact of a lot variable that really affect the company performance most importantly when guidelines and policy risks are not sensitive or predictive enough.

Transaction exposure is the most important foreign exchange risk to the Group measuring it each month for monitoring and control purposes that will best guide the decision-making activities of the company hedging until the maturity of the exposure. Translation exposure is likewise monitored from time to time hedging longer than the maturity of the exposure while economic risk exposure is not all measured. Unlike the number of companies that decide on their hedging strategies according to their own perception of future changes in the exchange rates, Kudelski is generally not concerned with predicting such exposure variables and does not use any forecasting model to guide the financial assets and liabilities of the firm ( 2003).    

A central unit that manages the Group’s hedging practices exists although the company’s foreign exchange risk management policy is not centralized utilizing derivatives to monitor and control transaction exposure in the form of options and swaps along with forwards and cash flow matching. Natural hedging techniques are used by the organization in managing transaction exposure primarily because the approach is simple and lacks transaction costs. On the other hand, futures and asset liability management are never used due to accounting problems and complex features. Forward foreign exchange contracts with 3 to 6 months maturity, currency swaps with 3 months maximum maturity, and zero cost option strategies (also with 3 to 6 months maturity) are the hedging tools used to protect foreign currency positions of the company and its subsidiaries. Moreover, income and cost exposure in US dollar and Euro are hedged by the Group using derivatives while options are utilized for predictable changes of currencies ( 2003).   

            Furthermore, Kudelski Group also uses year-end exchange rates in translating assets, liabilities, and other financial statement dominated in foreign currencies while the average rate of exchange for the year are utilized for the revenues and costs in foreign currencies. Transactions in foreign currencies are converted at the rate of exchange prevailing at the transaction dates while receivables and payables translated at year-end rates ( 2003).

 

Recommendations

In general, exchange rates are volatile and open short or long currency positions can lead to sizeable losses. Capital thus needs to be held to cover such possibilities.  As such any individual or company engaged in overseas business should be aware of the risks of currency fluctuations.

Based on the presented case of Kudelski group, the company should employ sensitive means to measure its foreign exchange risk exposure, particularly it economic risk exposure. Evidently, the company does not utilize economic exposure foreign exchange risk management tools thereby neglecting the relevance and accountability of the firm’s future value as well as its obligations to business partners and associates In this competitive and aggressive international business setting, companies should be well aware of all the variables that could enhance organizational success and growth in order to maximize the full potential of the company. 

Hedging the economic exposure of the organization will regularly affirm the overall value of the company. Sustaining such hedge will result to more secure assets of the firm in order to attract more transaction from where the company can maximize and take advantage of profits as well as opportunities. As such, economic exposure risk considerations should not be set aside since its careful analysis can provide the Group with essential strategic financial options. The complexity and seemingly irrelevant benefits of managing economic exposure should be overcome by the company’s treasury to explore extensively the financial capabilities and limitations of the firm. This calls for a careful review and restructuring of the company’s governing foreign exchange exposure risk management policies.

Since the company ventures on foreign transactions, stability of the currencies that they deal with should be effectively predicted through efficient monitoring of changes in the currency exchange rates of the clients whose financial accounts are not in the same denomination as that of the firm. This could be realized by considering the uses and advantages of forecast models to better understand, efficiently handle and accurately predict the changes in the foreign currency exchange market. 

Moreover, the Group as a business organization should effectively gather and digest a large volume of information, including spot and forward exchange rates, currency conversion and funds transfer fees and government regulations regarding allowable transactions and currency controls in order to effectively and securely manage foreign exchange risks. The management should also be continuously aware of the subsidiaries’ balance sheet exposures, as well as cash flows and expected cash transactions to employ decisions that will most benefit the organization.

The continuous use of natural hedging and as well as efforts to limit external hedging approaches should be observed in the firm particularly when less expensive alternatives can be implemented to manage the foreign exchange exposure of the company. Since the use of forwards is the most economical internal hedging instrument, Kudelski can take advantage of its simple feature. On the other hand, the use of options should be regulated since it entails large transaction cost that the company will shoulder.   

 

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