Strategies for mitigating foreign exchange risk
Abstract: Foreign exchange risk management is important for multinational companies since changes in exchange rates can have significant effects on financial results. Following their extensive international operations, Thule Group is one such organization. Although the company’s treasury department can measure the exposures to exchange rates, they do not engage in statistical measurements to support hedging decisions. Therefore, the purpose of this thesis is to investigate the foreign exchange exposures and the associated risks at Thule Group through statistical procedures, assess the company’s current hedging strategy and suggest improvements to the future hedging practices. The method used to obtain the foreign exchange exposures and risks is Exposure-Based Cash Flow-at-Risk (CFaR). The analysis shows that the major statistical exposures of Thule Group are in EUR/SEK, CNY/SEK and EUR/USD. The EUR/SEK is the largest exposure, driven by substantial net cash flow contributions in EUR and the highly correlated currencies of the European market. The risks are obtained by simulating the total operational cash flow. The simulated quarterly CFaR is 136 MSEK, meaning that the quarterly unexpected loss in operational cash flow will not exceed 136 MSEK with 95% confidence. The majority of the risk is contributed to factors other than foreign exchange rates. The assessment of Thule Group’s current hedging strategy shows that the hedge portfolio does not necessarily lower the exposure to risk. However, it partly decreases the volatility of cash flow, one of the goals set by the organization. A possible improvement to the hedging strategy is to hedge the EUR/SEK exposure using monthly hedge contracts of 90 MSEK. Using this strategy decreases the CFaR by 6.5%. The risk capacity of Thule Group is high, and the company’s total risk profile is low. Therefore, the CFaR can be accommodated within the existing financial capacity of the company. Consequently, Thule Group is well positioned to take on more risk, for example, by increasing capital expenditure or compensating stakeholders. Finally, a theoretically supported improvement to the hedging program is to limit the use of financial hedging contracts. The benefits of a hedging program are few when the total risk profile is low.
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