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Joseph Neu

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Co ntributin g Editors
Ha l Dnvis
Dona ld Dunn

managers, afte r a depress in g 199 4, were in


somet hin g of a mood to party after M ex ico.
The irres istibl e temptati on to score big by bettin g o n, and perhaps prompting, deva lu atio ns
in simi larl y f ixed currencies w ill likely ca use
tequi la to flow aga in.
For spec ul ators , a nd tr eas ure rs n e rv o u s
about currency risk in these coun tr ies, the lesso n of Mexico's max i clearly applies:
Ignore economic fundamentals at your pe ril.
Plan for the worse when fundamentals look to
turn, but don't expect devaluations if fundamentals are good. Fixed regimes fall apart because of
fundamentals, not knock-on reactions.
" Last week may have been someth in g of a
knee-jerk reac tion " says o ne treasury ce nter
manager in Hong Ko ng, " however, we' ve see n
that pe gs, f ixe d exc h ange- mech anisms , or
whatever they may be ca ll ed, don't last forever, so th ere is so me ju stifi cat io n for m arket
nervousness."
Take Ho ng Kong, fo r exa mpl e, which due to
its currency board reg im e, is held by many to
have o ne the most ce rtain of the Asian pegs.
W hile its do ll ar holds aga in st m arket press ure
toda y, the economic fundamentals th at all ow
thi s are subj ect to c hange in a few years when
Hong Kong returns to Ch in a. Whil e this is an
ex treme examp le, pendin g shifts in a currency's eco nom ic/po liti ca l environm ent should
always be eva lu ated carefull y- in partic ular,
if th e currency is fixed to another currency at a
va lue that is bid up by portfoli o in vestment.

Managing exposure the old-fashioned way


In emerging markets, devalu ation ri sk shou ld be
managed by assess ing eco nomic fundame nta ls,
li ke current accou nt deficits, and add in g a risk
prem ium to investments in pote nti all y vuln erable currenc ies. In other word s, without derivatives- and in many exotic currenc ies there are
few- deva lu atio n ri sks ca n on ly be managed
as country ri sks.
In li ght of las t week 's " hot m oney" tes t of
f ixed exc h ange rates, co untry-ri sk c riter i a
shou ld also be used in co njun cti on with statistica l fina nc ial risk mode ls. With tod ay's preoccup ation with deri vat ives, it is easy to forget
that o ld -fas hi oned country-r isk assessm ents
are an important part of th e internationa l treasurer's too l kit (see IT, 3/7/94). Th ey are crucial fo r determinin g wh ether specu lative pres
sure w ill lead to a devalu ation or a cri sis.
8

Tax/treasury synerg ies

Profess io na l Contributors
Robert He rz

Cosh-Tax
Investment Links

Assoc iate Nationa l Di rector o f


Accounti ng and SEC Services
Coopers & Lybra ncl
Peter Connors
Director, Tax Services
International Cap ital Markets
Ern st & Young

Treasury's financial investments are yet another area where tax considerations are useful.

Jeffrey Wallace
Mant~ging

Director

Greenw ich Trea su r)' Ad viso rs

In ves tin g co rporate cas h in fi nanc ial in str uments is an area where m any treas uri es ca n
ad d to th e bottom lin e- simply by b e in g
aware of after tax conseq uences.
Capital gains and losses. One pl ace to sta rt
is with the co mpany's net cap ita l tax position,
ex plain s Robert Gordon, pres ident of Twentyfirst Sec uriti es Co mpa ny in N ew York. If you
have capital losses, th e in come you make o n
ca pital ga in s ca n be tax f ree. Thi s is an important co nsideration , because so m e lu crat ive
arbitrage opportun it ies ca n on ly be used by
co mpa ni es with th e ab ili ty to offset capita l
gain s.
Th e co mpany's net cap ital ga in s ta x position
is also an important cons id erati o n in determ inin g whether add in g va lue to fi nanc ial in vestment oppo rtuni t ies is somet hin g treas u ry
should devote resou rces to in the first pl ace.
" Tr eas ure 1s with n et l osses," notes Mr .
Gordon , "a re often better off buy ing T-bill s
and going to sleep- w hy waste m anagement
time to ad d valu e if it is nega ted after-tax."
Tax loopholes. Whil e dwind lin g in th e US
and elsew here, loop ho les sti ll present opportu niti es o n occas io n, and are a second t hin g to
look for . For examp le, US ta xpayers, w hil e
large ly restr icted from borrowing funds to purchase ta x exempt sec urities, are arrowed a de
minimi s exemption to invest up to 2% of its
gro ss as sets in tax exe mpt f in anc ial in vestments. Large co mpani es- e.g., with $1 b illi o n
in gross assets o r more- may have a significa nt amount, $20 m illi on, e ligib le for this
loop ho le: borrow mon ey, deduct the inte rest
expense, and ea rn tax-e xe mpt interest in come .
Dividend received deductions. Yet, another
tax-dr ive n investment involves oppo rtuniti es to
rece ive dividends fro m other corporatio ns eli gib le for d iv id end-rece ived ded uct ions . Th ese
oppo rtuniti es ca n be fo und in preferred stoc k
investments, o r in more arbitrage-or iented, mispriced Peres. Di vide nd in come, post deducti o n,
and cap ital gai ns offset with losses, says Mr .
Gordon , ca n produ ce ni ce after-tax 1eturn s.
Cros s-border strategies ca n do eve n more.
-

David Veres
Pa rtner
Rogers & W e ll s
Corporate Adviso rs
H<:1n s Pohlslhroeder
i\ssist <:1n t Treasurer
Co lgatePa lmo live

David RuscHe
Assistant Treasurer
Genera l Electric
Arv\nd Sodhani
Vice Pres ident and Treasu rer
Intel Corp.

A. lohn Kear ney


Assis tant Treasurer
M erck & Co.
Ju anita Hin shaw

Vice President and Treasurer


Monsanto
Academ ic Advi so rs
Lee RellHners
Professor
INSEAD
Dona ld Lessa rd
Professor
Massa chu sett s
Instit ute of Techn o logy
Richard Lev ich
Professor
Stern Schoo l of Business
New York University
Steve H anke
Professo r
The \alms H opk ins University

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Interna tiona l Treasurer/j anuary 23, 1995