Friday, February 28, 2014

Risk management series: Foreign exchange risk

Hey guys, how are you doing? Today I will be discussing foreign exchange risk. No, this isn’t an article about FOREX trading (I don’t do that shit here). This is an article about analysing the foreign exchange risk exposures of companies. I still remember that FOREX trading was really hot a few months back with young people. Maybe it’s still going strong, or maybe they realized that it takes more than looking at fucking charts to make money and that they were just gambling. Anyway, let’s get down to business.

Investors need to identify the amount of the company’s accounts payable that are in foreign currencies. If the company has a large amount of accounts payable (relative to its total assets) that are in a foreign currency, its financial position could be compromised if the foreign currency appreciates against the company’s functional currency. This is the case as the company might have to dig deeper into its cash reserves or take on more debt to convert enough foreign currency to settle its accounts payable.  I would want a company with a large amount of foreign currency accounts payable to generate enough profits in those foreign currencies to comfortably cover its accounts payable.  Otherwise, I would want the company to either have cash & investments denominated in the foreign currency or hedge its foreign currency exposure with derivatives.

The same goes for significant borrowings (relative to the company’s total assets) denominated in foreign currencies. I would like the company to have enough cash & investments and profits in those currencies to cover the interest and principal payments of its foreign debts. Otherwise, I would want the company to hedge its foreign currency exposure.

Another source of foreign currency risk is that a company’s profitability could get impaired if there’s a broad appreciation in the currency of the country where the company’s manufacturing facilities are located. This is the case as the company’s products will become more expensive in other countries and it might lose market share. Alternatively, the company might decide to maintain market share by not passing on the increased manufacturing costs to its customers and take a hit to its profit margins instead. To reduce the risk of something like this happening, the company can establish manufacturing facilities in a few different countries.  This will allow the company to shift production to other countries if manufacturing in a certain country becomes too expensive due to currency appreciation. I personally have never investigated how geographically diversified a company’s manufacturing facilities are, so I don’t know if such information can be easily found. However, I’m interested to perform such an investigation in the future. It will be my little pet project.


A quick update on the Greedy Dragon portfolio, I recently took a position in Kasikornbank and sold my Tifa Finance shares. As always, thank you for reading. Take care, stay rational and flip off anyone who promises you easy money through forex trading.

2 comments:

  1. Globalisation comes with a price - forex risk.

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    1. With some adjustments to operations and proper selection of financing and hedging, forex risk is definitely manageable

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