Currency Risk Management

Austin Missoula Manila
Empirical Solutions, LLC

Preemptive Currency Risk Management
Empirical Solutions Empirical Solutions
PREEMPTIVE RISK MANAGEMENT | Protect. One Client at a Time.
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We help our clients generate consistent results. We:
1. Reduce FX earnings risk and protect their balance sheet
2. Save clients money and reduce their cost of hedging
3. Reduce the staffing needed to support a world class hedging
program so they can focus on their core business
We are paid only by our client, and therefore we can and do
provide conflict-free advice and act as their unbiased advocate.

NOTE: We do NOT pretend to know the future. That is why
we encourage clients to hedge and avoid risky speculation.
EMPIRICAL: Who are we? What do we do?
Copyright 2013 Empirical Solutions, LLC. All rights reserved. www.empiricalresults.net

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Prediction is very difficult, especially about the future. (Niels
Bohr, the famous Danish physicist)
Having endeavored to forecast exchange rates for more than
half a century, I have understandably developed significant
humility about my ability in this area. (Alan Greenspan, former
U.S. Federal Reserve Chairman)
If you think writing about the fortunes of the stock market is
tricky, try getting your arms around currencies. (Bill Gross, Co-
Founder of Pacific Investment Management and manager of
PIMCO's $270.0 billion Total Return Fund)
NOBODY HAS A CRYSTAL BALL THAT ALWAYS WORKS

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WHAT ONE THING DO ALL THESE FIRMS HAVE IN COMMON?

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FX RISK MANAGEMENT ROADMAP

1. Quantifying Currency Risk: The Bottom Line Impact
2. Explore FX Impact: Where Does It Affect Your Company?
3. Which Firms Hedge Today?
4. Benefits of Hedging
5. Hedging Best Practices
6. Background on Empirical Solutions, LLC
7. Next Steps?

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! Crises are a reoccurring phenomenon (Asia 97, Russia and LTCM 98,
9/11/01, Lehman 08, Greece 10/12, Cyprus 13).
! Currency controls have never worked over longer periods of time (Bretton
Woods, ERM, Plaza Accord, Jamaica Agreement).
! Central banks continue to actively intervene in currency values (Bank of
Japan, China, Swiss National Bank, and the U.S. FED etc.).

CURRENCY RISK: An old problem.
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CURRENCY RISK: Overview of VAR (Value at Risk).
Mean
Spot
VaR is a method of quantifying potential loss in uncertain situations. VaR
measures the value of loss which is unlikely to be exceeded a defined % of
the time, called the confidence interval (CI). For example, a 95% $1mm
VaR, means that 95% of the time, the loss will be $1mm or less.

In this presentation, we only refer to the left tail which refers
purely to the probability of losses (left-hand side of the normal
probability curve, shown on the left).

For example: a 95% Annual VaR on a $1mm contract,
assuming annual vol=13% is calculated as follows:
95% VaR = z-value*StdDev (annual)*contract value
95% VaR = 1.64*13%*$1M = $213,200 risk per year.

Correct interpretation: 95% of the time, the probable loss
of that contract would be no more than $213,200 but 5%
of the time it is expected to be larger than $213,200.
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CURRENCY RISK: Volatility is not limited to longer periods of time.
6 months
5 years
USDPHP CADPHP AUDPHP
36-47 39-47 40-49
41-45
40-46
36-44
Note: 5 year data reflects most recent data but to make the point that short term moves can be significant, the
6 month charts reflect one of the higher volatility 6 month periods within the last 5 years.
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CURRENCY RISK: Currency risk can often exceed profit margins.
0
5
10
15
20
25
30
35
USDPHP CADPHP AUDPHP
1 Year
3 Year
5 Year
Value at Risk on $100M Notional
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7. Next Steps?

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FX IMPACT: How does FX affect your business today?
These questions can help us understand how FX affects your business:
" Does your firm receive payments in foreign currencies?
" Does your firm ever pay expenses in foreign currencies?
" Do you have foreign denominated assets?
" Do you have any debt that is denominated in another currency?
" Do you customers have foreign currency risk?
" Does your competition (even if you do not) have foreign currency exposure?
" Do your suppliers have currency risk imbedded in their business?
" If you do hedge, do you have a formal (written) hedging policy in place?
" How does your firm measure FX risk and measure hedge effectiveness?
" What procedures do you follow to minimize the cost of hedging?
" Do you thoroughly hedge or sometimes take a speculative view on rates?

`
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7. Next Steps?

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Disclaimer: Currency trading carries substantial risk of loss, is not for everyone and only risk-capital should be used.
Proprietary and Confidential. ( Copyright 2012 Empirical Solutions, LLC. All rights reserved.)

NEARLY ALL GLOBAL LEADERS HEDGE THEIR FX RISK.
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! Mainstream and considered a best-practice.
! Hedging is GAAP compliant since 1998. FASB has established standard
accounting procedures for hedging in US and IASB for the rest of the world.

HEDGING: A widely recognized best practice.
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7. Next Steps?

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1. More predictable earnings. Good for Investor Relations (IR).
2. Protect the reputation of your firm, by not letting negative stories about forex
losses cloud operating accomplishments in the core business.
3. Greater access to capital. Investors put a premium on management that
prioritizes risk-management as well as growth.
4. Less volatile companies get better borrowing terms.
5. Investors reward more stable firms with higher public valuations.
6. Stop and imagine the damage to team morale if an entire years worth of
hard work is erased by FX risk that could have been hedged. What is the
value of protecting the enthusiasm of hard working employees?
7. Minimize cash crunches caused by unexpected currency losses.
8. Avoid re-financing risks (such as having to take a loss on existing loan).

BENEFITS OF HEDGING: The benefits are multi-dimensional.
Benefits can include:
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! IPOs
! Mergers
! Acquisitions
! Vendor terms
! Bank line negotiation
! Investor relations strategy
! Sourcing expansion capital

BENEFITS OF HEDGING: It impacts firm-wide strategy.
Hedging can positively impact a wide variety of corporate actions:
The closer we work together, the more effectively we can help you make sure
that FX risk does not impact seemingly unrelated areas of your operations.
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7. Next Steps?

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! Hiring outside expertise. Less expensive than hiring experienced full time
staff (minimum of two). Even Fortune 500 firms use external experts.
! Firmly negotiate with the liquidity providers (banks) to get best rates.
! Integrate balance sheet and income hedging approach (saves money)
! Net exposures to do the least number of transactions (and save fees).
! Triangulation and natural hedging for non-G7 currencies in particular.
Other Best Practices:
! Inclusion of internal and external accountants early in the process.
! Analytics track results and sources of variances for accountability.
! Consistent hedging policy to avoid the temptation of market timing.


HEDGING BEST PRACTICES: If worth doing, best do it right.
Cost saving best practices include:
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BANKS: Important source of liquidity and conflicts of interest.

Banks provide the products you use to actually hedge. However, just because they
are your bank, does NOT mean they work for you.

Heres an excerpt from a term sheet Empirical Solutions recently reviewed for a Client:


! Bank-proposed hedge structures will often be lowest-risk/highest return for
the bank or will be the products that are easiest to get approved by their
credit department and not necessarily the best ones for you.
! Bank trading agreements (ISDAs) explicitly favor the bank, but most banks
will allow you to add in additional language that helps make it more two-way
(but you have to know how to do this and coordinate with attorneys).
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Recent press headlines prove the point:

BANKS: Size does not guarantee good disclosure standards.
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7. Next Steps?

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Empirical: How we conduct business makes us different.
! We listen. We ask questions. We want to understand your business.
! We prioritize based on your business objectives (we get paid either way).
! We work for you. We have no commercial relationships with vendors.
! We do not sell software. We developed our own enterprise class system and
you get the benefit of it as part of retaining us to advise you.
! We do not make you use our software (we do the work). This saves your staff
a lot of time. No need to learn and use yet another software system.
! If you use an ERP system like SAP, our program can work seamlessly to
leverage the benefit of your ERP reporting power.
! Bottom line, we work to save you money and time and help you reduce risk.

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! Registered Commodities Trading Advisor (CTA) with the CFTC.
! NFA Member Approved (ID #0424405).
! Management has over two decades of practical, hands-on currency
and risk-management experience.
! Owned by management. No external affiliations (no conflicts).
! Clients include both U.S. based firms and international businesses.
! Empirical also operates under Currency Risk Management, LLC in both
the United States and in Asia per agreement.
Empirical: Independent and experienced.

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! Existing clients include:
! U.S. based firms
! International businesses
! Publicly traded firms
! Private, closely held firms
! Sample of industries served:
! A golf and sports gear firm
! A large automobile and bicycle retailing operation
! A firm that sells imaging systems for manufacturing process control
! Publicly listed real estate company
Empirical: We serve many different types of businesses.

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Stefan Whitwell, CFA, CIPM, Managing Director
! Two decades of investment and risk management experience; expertise
includes both traditional and alternative assets.
! Previous experience includes institutional and hedge fund coverage at Credit
Suisse First Boston and Goldman Sachs, and mergers and acquisitions
investment banking at James D. Wolfensohn, Incorporated.
! Awarded the Chartered Financial Analyst designation (Charter #40140) in 2000
and the Certificate in Investment Performance Measurement (Certificate
#000892) in 2012 by the CFA Institute. Served on one of the CFA Exam
standards setting committees for the CFA Institute in the summer of 2012.
! Graduated from the Wharton School at the University of Pennsylvania with a
Bachelor of Science in economics and concentration in finance.
! Listed with the National Futures Association as Principal, registered as an
Associated Person, Forex Associated Person and Associate Member of the
National Futures Association (NFA ID #0277030).
Leadership

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Paul Stafford, Managing Director
! Founded a currency risk management business; built models used by
corporations for risk management that analytically incorporate a variety of
derivatives and Monte Carlo-based tools to aid decision making.
! Previously worked as an engineer at NASA-Ames Research Center, where he
developed liquid helium near-absolute zero cooled infrared sensing arrays, and
the related processing electronics, to extend the observable universe.
! Subsequently recruited by Hewlett Packard Company (Palo Alto) to solve some
challenges calibrating Microwave Vector Signal Generators, which were used to
generate modulation test signals such as Barker-coded radar pulses and
Doppler-shifted satellite signals. Developed a technique for calibrating Vector
Signal Analyzers which resulted in a patent (US Patent 5,332,974) that is now
widely used in the electronics manufacturing business.
! Bachelor of Science degree in engineering from UC Berkeley, and a Master's
degree in engineering from Stanford University.
Leadership

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7. Next Steps?

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Disclaimer: Currency trading carries substantial risk of loss, is not for everyone and only risk-capital should be used.
Proprietary and Confidential. ( Copyright 2012 Empirical Solutions, LLC. All rights reserved.)

Next steps?
Your Firm
Empirical Solutions
We manage your entire hedging program for you, determining and helping execute the
hedge structure based on your revenue forecasts and trial balance data.

Data (flat file, CSV) is sent to us via a secure file transfer protocol such as Drop Box or
BitTorrentSync. We send remeasurement data, trade execution, accounting rates, hedging
results and variance analysis. We operate the OLAP-based engine so your IT and finance
personnel do not need to learn and operate yet another complex software tool.

IMPLEMENTATION: Overview.
Empirical Solutions
Day of Month Item Sender
Last Work Day (WD) of month Latest BS, CF forecast
Accounting Rate
Trades to be executed
As-executed contract data
Company
CRM
CRM
Company/Bank

WD+5 (previous month close)
WD+6
WD+7
Actual NMA, Income statement
Company
CRM
Company/Bank
Netting Day (typically 3
rd

Wednesday
LC cash delivery (accuracy not critical)
Company

CRM
Company/Bank
IMPLEMENTATION: Schedule of data exchanges and trades.
Note: CRM is the name of Empiricals currency risk management business unit.
Empirical Solutions
IMPLEMENTATION: Benefit from our world-class FX-Engine.
Clients benefit from the FX-Engine at no additional charge:
1. Excel can only think in two dimensions, but hedging requires many
more (currency, day, month, portfolio, entity, counterparty, forward
rate, natural accounts et cetera).
2. The organization of spreadsheets is often linked to the people that
create them, and the expected use for the information. As staffing
and risk management requirements change, spreadsheets become
error-prone and eventually unusable.
3. Modern OLAP (online analytical processing): Dimensions organize
data into multi-dimensional data cubes.
4. We built and use an OLAP-based FX Risk Engine.
Empirical Solutions
IMPLEMENTATION: Our Trade Reduction Tool saves clients money.
Less is More (Beneficial):
1. Companies with non-G-7 functional currencies must sometimes hedge cross
currency pairs.
2. Empiricals Trade Reduction Tool reduces hedging costs in two ways: First we
decompose cross-trades into two equivalent USD-based trades. This reduces
total spread costs. Second, an algorithm then aggregates trades as possible,
reducing the total volume of trades. In the example below, 18 cross-currency
hedges have been reduced to only 10 USD-based trades.
Empirical Solutions
IMPLEMENTATION: We employ the full range of hedging methods.
Here is an example of one hedging method called layering that
demonstrates how dramatically financial volatility can be reduced:
Monthly GBP costs
Costs Unhedged 6 month avg. 12 month avg.
Std Deviation 179,604 114,369 53,493
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Stefan Whitwell, CFA, CIPM (Austin, Texas)
office: (877) 936-3372 ext. 701
cell: (917) 214-6833
email: stefan@empiricalresults.net

Contact Information
Paul Stafford (Missoula, Montana)
office: (877) 936-3372 ext. 702
cell: (406) 546-8410
email: paul@empiricalresults.net


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Austin Missoula Manila

Empirical Solutions, LLC

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