Daily Profit Decomposition from Fluctuations in Interest Rates and Exchange Rates Extended with Inventory

Abstract: Multinational companies have consistently not been able to explain the impact currency and interest rates fluctuations have on their profits. To be able to account for these effects, thorough visibility is required. Epiroc Örebro is a global supplier of products and services within mining and infrastructure, with sales in more than 150 countries. The largest markets are Europe, North and South America and Asia. Naturally, with exposure to many different currencies and interest rates, it lies in the company’s interest to fully grasp and visualize the effects of these risk factors. The aim of this study is to provide and apply a performance attribution model to Epiroc Örebro, in order to fully grasp and visualize, how foreign exchange rates and interest rates affect the profits of the company’s operations on a daily basis. Main focus is on incorporating inventory into the performance attribution model. To fulfill the purpose of this thesis, literature studies on performance attribution models, foreign exchange risk, and interest rate risks were conducted. Epiroc Group and Epiroc Örebro were studied to get the full picture of their risk exposures. Consequently, a generic framework for performance attribution was extended, established and provided to their daily operations. The rigorous framework describes profit decomposition (ΔNPVt) with respect to risk factors. In summary, this mathematical model comprises of: a Taylor approximation for changes in price with several error terms, terms accounting for holding foreign currencies and assets, purchasing and sales of currencies and assets and lastly, a term accounting for currency fluctuations. See eq. (4.25) to eq. (4.35). The focus of this report is the addition of inventory into the existing performance attribution model. Inventory is valued to last purchase price and the value of inventory is only affected by price changes and exchange rate fluctuations. The main result of this study is that inventory can be incorporated into the performance attribution model. The model is comprehensive and fully explains the company’s NPV changes on a daily basis in detail. Furthermore, the conclusion is that the model can be extended to handle inventory, but several additions and adjustments are still to be added. Work regarding data extraction and cash flow prognosis will be required to scale the model and to enable real time use.