Euro in Crisis

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					            Structures & Strategies to
            Manage Foreign Exchange
                  Rate Volatility
                            Presented by: Gulya Belchuk
                                           Dave Maher
                                           David Vining

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     Purpose of Today’s Discussion
     With analyst reviewing every detail of quarterly and annual reports along with
     business and economic forecasts, public companies are having to manage their
     daily business along with future expectations. Foreign currency recurring items
     can add to this forecasting problem when exchange rates are very volatile. Today’s
     discussion will illustrate different approaches that companies use to deal with
     foreign exchange rate volatility.

     In a recent New York Times interview, Jack Bogle explained why Vanguard Funds
     had been so successful and why they would continue to be successful. He
     attributed this success to three words:

                               “Strategy follows Structure”

     Let’s explore how structure may help with forecast problems while smoothing
     exchange rate volatility.

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            State of the Foreign Exchange Market
            Structures for Forecast Management
            Hedging Instruments

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     Euro in Crisis

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     Euro in Crisis
            Euro Currency and Concept
            What About Spain
            Flight to Quality
            Not Contained to Europe
            The Euro Effect

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     Euro Currency and Concept
            Sovereign Debt Load Weighing on Confidence
            EU Charter and Constitution a Hindrance
            Greece is the Tip of the Iceberg
            Spain is 5 Times the Size of Greece
            Greece GDP $300 billion
            Cost of Bailout $350 billion
            No Solution without Germany’s Buy In

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     What About Spain

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     Flight to Quality

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     Not Contained to Europe
            Emerging Market Currencies Fall as Well
            EU is the Biggest Export Market for China
            European Recession = Chinese Slowdown
            China Slows – Asia Does as Well

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     Brazilian Real

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     Euro Effect on Equities
            Undeniable Correlation
            Recent Signs of a Correlation Split?
            Equity Markets Moved Up Despite the Hard Euro
            Sell Off to 1.2040
            Divergence Was Brief

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     Back Stronger than Ever

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     Spanish Yields Today

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     YTD Currency Value Change

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     Calendar of Recent Events
            July 24th – Euro Low of 1.2043
            July 26th – ECB President Draghi announces “The
            ECB will do Whatever It Takes to Save the Euro”
            September 6th – ECB Announces Unlimited Bond
            Buying Program (3 years and under)
            September 12th – German Court Ratifies ESM
            Bailout Legality
            September 12th – Euro Trades at 1.2937 High and
            S&P Hits 1439
            September 13th – FOMC Announcement ???

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            Despite Recent Gains the Euro is likely to
            Encounter Strong Resistance between
            1.2900 and 1.3100
            Euro will gradually Trade Lower over
            A Lower Euro will Benefit Europe
            Greek Exit from Euro still a Possibility

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     Structures for Forecast Management
            No Hedge
            Rolling Hedge
            Layered Hedge
            Rolling Layered Hedge

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     No Hedge
     The decision not to hedge foreign currency flows establishes a policy structure to
     handle transactions as they occur or by need. This structure allows the company
     the flexibility to change payment amounts without having to change hedge
     contracts. Unfortunately as exchange rates change, this structure prevents the
     company from being able to forecast the US dollar values of these flows and
     smooth volatility. The company uses the exchange rate of the day to convert the

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     Rolling Hedge
     To create a reliable way to forecast the US dollar value of foreign currency flows, a
     company could use a structure which hedges the first year of estimated foreign
     currency flows. This would create a cliff at the end of the year. Rolling the hedge
     after each month’s flow to the same month next year would remove the cliff and
     allow the company to reliably forecast the US dollar value of the foreign currency
     flow. However, this structure follows the market rather than smooth rate

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     Layered Hedge
     A structure that will smooth rate volatility entails dollar cost averaging of the
     hedge rates. This structure requires that the company layer hedges through out
     the year. An example of this layering would be that the company hedge 100% of
     the first quarter flows, 75% of second quarter flows, 50% of third quarter flows
     and 25% of fourth quarter flows. Then after each quarter flow transacts, the
     company would add 25% to the remaining quarters. Again, this creates a cliff.

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     Rolling Layered Hedge
     Combining the Rolling and Layered Hedges creates a reliable forecasting structure
     that will smooth exchange rate volatility. An example of the Rolling Layered Hedge
     would entail the company layering hedges 100% for first quarter, 75% for second
     quarter, 50% for third quarter and 25% for fourth quarter. Then after each quarter
     flow transacts, the company would add 25% to the remaining quarters and 25%
     for the corresponding quarter of the next year.

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     Side-by-Side Comparison

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     Hedging Instruments
            Forward Contract
            Collar (Risk Reversal)
            Participating Forward
            Cap Risk Forward
            Side-by-Side Comparison

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     Forward Contract
     A Forward Contract is a contract between two counterparties to exchange one
     currency for another currency at a predetermined rate on a specific date or during
     a specific time period. Both counterparties are obligated to the terms of the

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     An Option Contract gives the buyer the right but not the obligation to exchange
     one currency for another currency at a predetermined rate on a specific date or
     during a specific time period. The buyer pays a non-refundable premium for this
     right. The seller of the option is obligated if the option is exercised.

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     Collar (Risk Reversal)
     A Collar is the sale of an out-of-the-money put option, creating premium, which is
     used to purchase an out-of-the-money call option. The Collar sets a cap for risk
     and a floor for opportunity. The seller of the option is obligated if that option is

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     Participating Forward
     A Participating Forward is the sale of an in-the-money put option, creating
     premium, which is used to purchase an out-of-the-money call option at the same
     strike price. The put option principal is a percentage (usually 50%) of the call
     option principal. The Participating Forward sets a cap for 100% of the risk and
     allows a percentage participation in the opportunity. The seller of the option is
     obligated if that option is exercised.

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     Cap Risk Forward
     A Cap Risk Forward is the sale of an in-the-money put option and purchase of an
     out-of-the-money call option at the same strike price. This creates an out-of-the-
     money synthetic forward with left over premium. The left over premium is used to
     purchase a deep out-of-the-money put. This sets a cap for 100% of the risk and
     allows a one-to-one participation in the opportunity at the deep out-of-the-money
     strike price. The seller of the option is obligated if that option is exercised.

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     Side-by-Side Comparison
                     Option vs Forward                  Collar vs Forward

            50% Participating Forward vs Forward   Cap Risk Forward vs Forward

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     The information in the presentation was prepared by David Vining and David Maher, Bank of Oklahoma, N.A.
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