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International Treasurer

The Corporate Treasurer's Guide to Global Financial Management

August 8, 1994
Currency/country risk
Mexico: Time to
Look for Cover?
Elections in Mexico are taking place against a
weakening economy and a currency that is
ripe for devaluation against the dollar.
Treasurers should be looking for cover and to
bring money out of Mexico in expectation of
the peso's continuing fall.
Following the elections on August 21, one of
the first decisions the new president (PAN
candidate de Cevallos?) wi ll need to make is
whether to officiall y devalue the peso- pro-
vided, of course, that the out-going adminis-
trat ion l eaves the decision for him to take.
Some market observers expect a mini-devalu-
ation of 5-10% followed by a widening of the
trading band with the dollar. An increase in
the daily band crawl to .0006% per day (6.4%
per year annualized) is anti cipated. Mexicans
as usual are getting their money out of pesos
in anticipation of the elections. In this context,
hedgi ng may 'oe t'ne prudent thing to do.
Stormy fundamentals
Mexico has not put in a stell ar economi c per-
formance in the wake of the passage of the
North American Free Trade Agreement. Since
the beginning of 1994, the Mexican peso has
devalued by 9.5% versus the doll ar. The out-
look for economic growth is falling with the
peso. Despite the Bolsa stock index jumping
48% in 1993, GDP expectations for 1994 are
being wh ittled down to around 1.4% (foll ow-
in g anemi c 0 .4% growt h l ast yea r ).
Presumably, economi c va lue li es further out
in Mexico's future.
In the absence of economic growth, treasurers
must ask themselves how long the Bank of
Mexico can continue to defend the peso.
Numerous factors should cast some doubt on
Continued on back page
Regional treasury management
Kodak's Latin
American Finance
Eastman Kodak promotes a group-level per-
spective with its local finance managers and
centralizes administrative and financial service
support with sub-regional centers.
W i th regional integration in the Western
Hemi sphere, corporate f inance funct ions are
looking at how they can appl y organizational
ini t i at i ves emp l oyed in Europe t o the
Americas. Kodak' s approach to this process
has been to first promote group-l evel objec-
tives with its local finance mangers in Latin
America and then to centrali ze treasury and
financia l operations in sub-regional centers
serving clusters of closely integrated countri es.
From country-level to group focus
Lat in Ameri can f in ance di rector Paul
Groeschel, upon returning to this posit ion
after a stint with Kodak-owned Sterli ng Drug,
set out to establi sh a group treasury mentality
in Latin America. He found that treasury oper-
ations were being managed to optimize coun-
try results rather than group results to share-
Often without reali zing it, the local finance
manager's choice to maximi ze country-l evel
resul ts can be detrimental to corporate objec-
tives. For example, one of Kod ak's country
ope rat ion s in Lat in America cons i stently
maintained a cash surplus of the equivalent of
$2 milli on. Rather than being remitted to the
parent, to invest or pay down the company's
debt, the country f inance manager was invest-
ing this cash locall y. The investment income
was being used to boost operating resu l ts,
helping the l ocal entity to meet its perfor-
mance targets. With each country engaged in
si mil ar locall y focused act ivi ties, the excess
cash being left unremitted was signi fica nt.
To help rectify this problem, Mr. Groeschel
establi shed a regiona l treasurer position to
Continued on page 2
Mexico: Time to
Look for Cover?
Coming elections in
Mexico create an air
of concern.
page 7
Kodak's Latin
American Finance
Getti ng its arms
around sub-regional
treasury management
page 7
New Tax Rules
for Hedging
The IRS issues its
hedge rul es in final
form and proposed
regs for centrali zed
ISDA Manages
Its Risk
What to learn from
the ISDA conference
on ri sk management.
page 4
FXpress Soon
Ready for Release
Windows-ease for an
FX management tool
suited to every corpo-
rate' s needs.
page 6
On-line Foreign
Exchange Services
Citicorp technology
for electronic trading,
confirmation, and set-
page 7
The Back Page
Continued from page 7
a peso defense. First off, interest rates-1 7%
nominal and 10% effective- are already hi gh.
Even without going hi gher, they are choking
economic activity whil e they increase the gov-
ernment defi cit.
Meanwhile, Mexico's foreign exc hange
reserves are declining. Some estimates put
them at $10 billion today, which is down sig-
nificantly from $17 billion at the end of April.
This lack of treasury resources makes it both
more diffi cult to defend the peso and stay cur-
rent on its non-peso debt. The spread over US
treasury rates for Mexican Brady bonds has
risen 100 basis points from 1993 levels.
To conserve its dwindling reserves, yet con-
tinue to prop up the peso, the Bank of Mexico
i s sa id to be selling tesobonos and buying
back cetes. Like cetes, Tesobonos are short-
term securiti es (28-360 day terms); but, whil e
denominated in pesos, they are indexed to the
doll ar. The peso amount paid at maturity -
set by dollar spot two-days prior- compen-
sates holders for principal and interest well in
excess of Libor (over 250 bps) . Still , they are a
cheaper source of funding than cetes.
By converting its short-term peso debt to
tesobonos, the Bank of Mexico is borrowing
agai nst the future value of the currency, hop-
ing that the markets will come back so that the
peso strengthens as its over $13 bill ion-worth
of tesobonos expire. If it does not, growi ng
tesobono exposure will press for an accelera-
ti on of the peso dec line; particularly, if
tesobonos come due in the wake of a govern-
ment-initiated devaluation. More borrowing,
spiraling interest rates, infl ation, and even the
prospect, albeit slim, of convertibility prob-
lems may result.
Time to hedge
Under an accelerat ing devaluation scenario,
now is the time to hedge. An official devalua-
tion coul d come shortly before or shortly after
the el ect ions. Of t he few available hedges,
one of the most attractive in the past has been
coberturas. Coberturas are simil ar to conven-
tional forwards only the premium is paid up
front in cash. At settlement, delivery reflects
the peso ga in or loss of the foward rate versus
actual spot.
Hi storicall y the premium has reflected some-
thing less than a traditional forward market's
expectations of devaluati on. Whil e the cober-
turas market is expected to come back, the
current cost of shorting cetes and buying
tesobonos-arbitraging the interest-rate parity
curve where forward rates provide equi valent
t reasu ry yields-is much l ess. However, for
most corporates, the approval process for such
an action may take treasurers beyond the cur-
rent window of opportunity.
Desp ite being rel at i vel y ex pensive at the
moment, coberturas have several redeeming
qualities. Execution is 1apid (just one phone
call away) and the contracts are standardi zed
for desired li quidi ty. Another important feature
is that they are approved in Mexico, whi ch
means they can be booked with a Mexican
subsidiary and not with the parent. This is not
something that can be done with other more
sophisticated instruments being touted by
banks in the US.
Buy now: the market will grow increasingly
unsettled in the days leading up to elections on
August 21. If short selling cetes for tesobonos
is not possible, one corporate we spoke with
recommends a 268-day cobertura at a premi-
um of around 7.0% or a 178-day cobertura at
a premium of 5.1 %.
Other risks
Naturall y, the buyer of coberturas assumes
cou nterparty cred it ri sk. Credit risk can be
cont ained by dealing with only top grade
banks. These banks inc lude, for instance,
Citibank Mexico, Banamex ($40 billion in
assets) or Banco Mex i cano ($ 13 billion in
Whil e Venezuela has demonstrated that the
prospect of exc hange co ntro l s in Lat in
Amer ica is not as outdated as it once seemed,
inconvert ibility risk with Mex ico is not very
real. However, uncertainty surrounding deval-
uat ion prospects is real. Accordingly, corpo-
rates should follow traders inst incts and avoid
exc hange transactions, coberturas or
tesobonos, that come clue in t he period
between the elections and the first month of
the president's new term (J anuary 1995).
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Editor & Publisher
Joseph Neu
Associate Edi tor
Donald Dunn
Professional Contributors
Robert Herz
Associate Nati onal Director of
Accounting and SEC Services
Coopers & Lybrand
Peter Connors
Director, Tax Services
Internati onal Capit al Markets
Ernst & Young
j effrey Wall ace
Managing Di rector
Greenwich Treasury Advisors
David Veres
Rogers & Well s

Mi chael O' Donnell
Vice Presidenl
Global Cash Management
Advisory Board
David Rusate
Ass istant Treasurer
General Electri c
Arvind Sodhani
Vice President and Treasurer
Intel Corp.
A. j ohn Kearney
Assistant Treasurer
Merck & Co.
Assistant Treasurer,
Canada & Emerging Markets

Lee Remmers
Donal d \_essard
Massachusett s
Institute of Technology
Ri chard Levich
Stern School of Busi ness
New York Uni versity
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Internati onal Treasurer/ August 8, 1994