Published in association with As a result, corporations around the world increasingly recognise the value in paying even more attention to managing financial risks Hedging has become imperative But how exactly you hedge financial risks? How you determine which risks to hedge first, and which ones (if any) should be left unhedged? The Handbook of Corporate Financial Risk Management, written by Stanley Myint and Fabrice Famery of BNP Paribas, addresses these problems, providing a detailed guide to financial risks facing corporates This book is an essential resource for all risk management professionals and practitioners - treasurers, CFOs, CROs, CEOs, Financial Directors, traders; accountants, consultants; corporate bankers, coverage officers, corporate financiers, private equity investors; academics and students in the field of corporate risk management “This topical book could not have come at a better moment It illustrates the power of a systematic, quantitative and analytical approach to financial risk, which is even more important in these turbulent times.” THOMAS BARTELT, Head of Financial Risk Controlling,Volkswagen “This Handbook is rigorous, clear and ruthlessly practical Up-to-date examples are drawn from the authors’ first-hand experience of meeting their own clients’ complex needs I can see this becoming required reading for anyone involved in managing corporate finance risk, and a key reference in the field.” DR HOWARD JONES, Senior Research Fellow in Finance, Saïd Business School, Oxford University “As a newly minted CFO this book, packed with real life business cases, has been instrumental in forming my views and action plan to address the Group’s corporate risk Highly recommended, if not a must, read for students and business professionals alike.” ERIC HAGEMAN, Chief Financial Officer, KPN Royal Dutch Telecom “This unique book provides a comprehensive overview of corporate risk management topics and will prove to be very useful to Treasurers and Financial Directors in their daily activities.” ALESSANDRO CANTA, Head of Group Finance, Enel The Handbook of Corporate Financial Risk Management By Stanley Myint & Fabrice Famery By Stanley Myint & Fabrice Famery A unique set of case studies draw on real-life industry experience and the challenges treasurers and treasuries face every day: • Funding • Interest rate and inflation risks • Currency risk • Credit risk • M&A related risks • Accounting and regulation “…rigorous, clear and ruthlessly practical” - a selection of praise for The Handbook of Corporate Financial Risk Management: The Handbook of Corporate Financial Risk Management The financial crisis destroyed long-cherished notions of risk and how to manage it In its wake, CFOs and Treasurers face a world where previous assumptions are no longer sure to hold, markets are becoming more unpredictable and no position is risk free PEFC Certified This book has been produced entirely from sustainable papers that are accredited as PEFC compliant www.pefc.org tho_CFRM_BNPP.indd Published in association with 19/10/2012 10:27 ✐ ✐ “myint” — 2012/10/18 — 17:47 — page i — #1 ✐ ✐ The Handbook of Corporate Financial Risk Management ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page ii — #2 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page iii — #3 ✐ ✐ The Handbook of Corporate Financial Risk Management by Stanley Myint and Fabrice Famery ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page iv — #4 ✐ ✐ Published by Risk Books, a Division of Incisive Media Investments Ltd Incisive Media 32–34 Broadwick Street London W1A 2HG Tel: +44(0) 20 7316 9000 E-mail: books@incisivemedia.com Sites: www.riskbooks.com www.incisivemedia.com © 2012 BNP Paribas ISBN 978-1-906348-92-2 British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Publisher: Nick Carver Commissioning Editor: Sarah Hastings Managing Editor: Lewis O’Sullivan Editorial Development: Alice Levick Designer: Lisa Ling Copy-edited and typeset by T&T Productions Ltd, London Printed and bound in the UK by Berforts Group Conditions of sale All rights reserved No part of this publication may be reproduced in any material form whether by photocopying or storing in any medium by electronic means whether or not transiently or incidentally to some other use for this publication without the prior written consent of the copyright owner except in accordance with the provisions of the Copyright, Designs and Patents Act 1988 or under the terms of a licence issued by the Copyright Licensing Agency Limited of Saffron House, 6–10 Kirby Street, London EC1N 8TS, UK Warning: the doing of any unauthorised act in relation to this work may result in both civil and criminal liability Every effort has been made to ensure the accuracy of the text at the time of publication, this includes efforts to contact each author to ensure the accuracy of their details at publication is correct However, no responsibility for loss occasioned to any person acting or refraining from acting as a result of the material contained in this publication will be accepted by the copyright owner, the editor, the authors or Incisive Media Many of the product names contained in this publication are registered trade marks, and Risk Books has made every effort to print them with the capitalisation and punctuation used by the trademark owner For reasons of textual clarity, it is not our house style to use symbols such as TM, ®, etc However, the absence of such symbols should not be taken to indicate absence of trademark protection; anyone wishing to use product names in the public domain should first clear such use with the product owner While best efforts have been intended for the preparation of this book, neither the publisher, the editor nor any of the potentially implicitly affiliated organisations accept responsibility for any errors, mistakes and or omissions it may provide or for any losses howsoever arising from or in reliance upon its information, meanings and interpretations by any parties ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page v — #5 ✐ ✐ For Sarah, Marko, Nora and Milica Sandrine, Edouard, Elisa and Victoria ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page vi — #6 ✐ ✐ BNP PARIBAS CORPORATE & INVESTMENT BANKING BNP Paribas Corporate & Investment Banking is one of the world’s pre-eminent investment banks, with expertise spanning fixed income, structured finance, global equities, commodity derivatives and corporate finance We are part of a global banking group that, in the first half of 2012, generated a net income of EUR 4.7 billion on EUR 20.0 billion of revenue, demonstrating persistent strength despite a challenging economic environment The fixed income division boasts world-class research and strategy, debt capital markets and corporate solutions teams offering, among others, risk management solutions across interest rates and foreign exchange, as well as debt management strategies It is one of the world’s leading partners for bond issuers and investors: for EUR-currency bond issues, BNP Paribas Corporate & Investment Banking has been ranked “No Lead Manager” by volume every year since 2009, while, for corporate EMEA bond issues (all currencies), it ranked no in 2009, 2010 and 2012 to date (Thomson Reuters) The Corporate Solutions Group is a team comprising 25 professionals, whose mandate is to assist key corporate clients of BNP Paribas on strategic issues related to funding and risk management vi ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page vii — #7 ✐ ✐ INDUSTRY ACCOLADES Euromoney Interest Rates Survey 2012 EuroWeek Awards 2012 Euromoney Awards for Excellence 2012 No.1 EUR Derivatives for Corporates Best Bank for: Corporate DCM in EUR (1st) Corporate DCM in USD (3rd) Best Debt House in Western Europe Best Bank in Western Europe vii ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page viii — #8 ✐ ✐ ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page ix — #9 ✐ ✐ Contents About the Authors Foreword Preface Introduction PART I FUNDING xiii xv xvii xix Funding How to Obtain a Credit Rating The Intermediated Exchange 19 Cash Tender Offer 27 Optimal Debt Duration via Merton’s Model 33 Funding Cost Drivers 41 PART II INTEREST RATE AND INFLATION RISKS 51 Interest Rate and Inflation Risks 53 How to Develop an Interest Rate Hedging Policy 57 How to Improve Your Fixed–Floating Mix and Duration 69 Impact of Fixed–Floating Policy on Company Valuation 93 Do You Need Inflation-Linked Debt? 107 10 Prehedging Interest Rate Risk 117 11 When to Prehedge 127 12 Constrained Maturity Optimisation 141 13 Asset and Liability Management 147 14 Pension Fund Asset and Liability Management 159 ix ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 366 — #398 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT and funding cost drivers, 41–50, 43, 44, 45, 46, 48 analysis, 42–3 background, 42 company objectives, 42 recommendations, 48–9 Step 1: historical analysis and peer benchmarking 43–6 Step 2: selecting main drivers, 46–7 Step 3: creating single- or multi-factor model of cost, 47 Step 4: analysing implications for company 47–8 and hedging policy, 57–68; see also hedging policy, developing and hedging uncertain exposures, 323–35, 325, 326, 327, 328, 329, 330, 331, 332, 333 analysis, 325 background, 324 company objectives, 324–5 and duration optimisation approach, step by step, 325 overview, 323–4 recommendations, 334 and inflation-linked debt, 107–16, 109, 111, 112, 113, 114 analysis, 109 assumptions, 111–12 background, 108–9 company objectives, 109 overview, 107–8 recommendations, 115 results, 113–14 risk management approach, step by step, 109 strategy application, 114–15 and interest rate and inflation risk, 53–166; see also main entry literature on case studies of, xxi literature on, xx–xxi and M&A-related risk, see M&A risk and managing FX risk with dynamic option strategy 227–37 background, 229 company objectives, 229–30 overview, 227–9 recommendations, 235–7 and Merton’s model, optimal debt duration via 33–40, 39 and monetising deferred consideration, see deferred consideration, monetising and netting FX risk, 185–98, 187, 189, 190, 191, 192, 193, 194, 195, 196, 197 analysis, 186–7 background, 186 company objectives, 186 and earnings-at-risk calculation, 190–3 and individual transaction exposures by subsidiary and currency, 189–90 overview, 185–6 recommendations, 197 step-by-step process of, 187–97 and obtaining credit rating, 9–18, 10 Step 1: forming initial rating expectations 12–13 Step 2: introductory agency meetings, 13–16 Step 3: preparing for management presentation 16–17 and optimal deposit composition, 263–76, 265, 268, 269, 270, 271, 272, 273, 274, 275 analysis, 264 background, 263–4 company objectives, 264 366 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 367 — #399 ✐ ✐ INDEX overview, 263 recommendations, 274 step by step, 264–74 practice of, literature on, xxi and prehedging credit risk, 277–83, 279, 281, 282 analysis, 278–9 background, 277–8 call spread, 281–2, 282 company objectives, 278 hedging strategy, 280 overview, 277 recommendations, 282–3 straight call, 280–1, 281 and prehedging interest rate risk, 117–25, 119, 120, 124 and accounting treatment, 122–4 analysis, 118 background, 118 and bond issuance, step by step, 118–24, 119 company objectives, 118 overview, 117–18 recommendations, 125 solutions, designing, 120–1 and uncertain maturity, 124 and uncertain starting date, 124 and prehedging, when to, 127–39, 128, 129, 130, 131, 132, 133, 134, 135, 136, 137, 138 background, 127 company objectives, 128 cost analysis, step by step, 129–38, 129 cost, forecasting from distance to local minimum, 134–6 cost, one into five years, 130–1 and dynamic of past swap rate hikes, 137–8 future cost, steepness as indicator of, 133–4 market background, 128–9 overview, 127 recent cost, comparison of, 131–2 recommendations, 138–9 step-by-step process of, 230–5, 231 Step 1: evaluating credit use of static strategies 230 Step 2: evaluating credit use of dynamic strategies, 230–4 Step 3: comparing cashflow volatilities of dynamic strategy versus CSA, 234–5 Step 4: tactical considerations, 235 surveys of, literature on, xxi theory of, literature on, xxi and translation risk, managing, 215–25, 218, 219, 220, 221, 223 analysis, 217–18, 218–24, 218 background, 217 company objectives, 217 overview, 215–17 recommendations, 224 cost drivers, funding, 41–50, 43, 44, 45, 46, 48 analysis, 42–3 background, 42; see also funding company objectives, 42 recommendations, 48–9 step-by-step process of, 43–8, 43 Step 1: historical analysis and peer benchmarking 43–6 Step 2: selecting main drivers, 46–7 Step 3: creating single- or multi-factor model of cost, 47 Step 4: analysing implications for company, 47–8 counterparty risk methodology, 246, 247, 248, 250–1, 252 367 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 368 — #400 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT analysis, 246 recommendations, 252–3 and single counterparty options, summary of, 250 counterparty risk protection, 255, 255–61, 256, 257, 258, 260 analysis, 255 background, 255 company objectives, 255 overview, 255 recommendations, 260 risk management approach, step by step, 256–60, 256 Step 1: calculating MTM distribution of derivative portfolio, 256–7 Step 2: calculating loss distribution using CDS-implied probabilities, 257–8 Step 3: exploring restructuring alternatives 258–60 covenants: currency risk on, 207–14, 208, 210 and accounting treatment, 213 analysis, 209–12 and average strike call, 211 and average strike collar, 211–12 and average strike forward, 212 background, 208–9 company objectives, 209 overview, 207–8 recommendations, 213 solutions, comparison of, 213 credit rating, obtaining, 9–18 analysis, 11–12, 11–12 company objectives, 10 introductory agency meetings, 13–16 and peer group analysis, 15–16 recommendations, 18 step-by-step process of, 10 Step 1: forming initial rating expectations 12–13 Step 2: introductory agency meetings, 13–16 Step 3: preparing for management presentation, 16–17 see also funding credit risk, 241–83 and counterparty risk methodology, 245–53, 246, 247, 248, 250–1, 252 analysis, 246 background, 245 company objectives, 246 overview, 245 recommendations, 252–3 and single counterparty options, summary of, 250 and counterparty risk protection, 255, 255–61, 256, 257, 258, 260 analysis, 255 background, 255 company objectives, 255 overview, 255 recommendations, 260 and optimal deposit composition, 263–76, 265, 268, 269, 270, 271, 272, 273, 274, 275 analysis, 264 background, 263–4 company objectives, 264 overview, 263 recommendations, 274 step by step, 264–74 prehedging, 277–83, 279, 281, 282 analysis, 278–9 background, 277–8 call spread, 281–2, 282 company objectives, 278 hedging strategy, 280 overview, 277 recommendations, 282–3 straight call, 280–1, 281 368 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 369 — #401 ✐ ✐ INDEX risk management approach, step by step, 246–52, 246 Step 1: identifying risky positions and possible actions to limit risk, 246–7 Step 2: calculating credit risk from each counterparty, 247–8 Step 3: suggesting optimal allocation under a portfolio approach, 248–52 Step 4: reducing and managing portfolio risk, 252 section overview, 241–3 credit valuation adjustment charge, increase in, xxvii currency risk, 169–237 and commodity-linked costs, 353–9, 354, 355, 356, 357, 358 analysis, 354 background, 353 company objectives, 353–4 overview, 353 recommendations, 358 results, 358 risk management approach, step by step, 354–8, 354 and commodity-linked revenues, 345–52; see also commodity-linked revenues and currency risk analysis, 345–6, 346, 347, 348, 349, 350, 351 background, 345 company objectives, 345 overview, 345 recommendations, 352 results, 351 risk management approach, step by step, 346–51 on covenants, 207–14, 208, 210 and accounting treatment, 213 analysis, 209–12 and average strike call, 211 and average strike collar, 211–12 and average strike forward, 212 background, 208–9 company objectives, 209 overview, 207–8 recommendations, 213 solutions, comparison of, 213 and credit risk, 241–3, 241–83 and counterparty risk methodology, 245–53 and emerging-market currencies, 199–206 background, 200 company objectives, 201 and econometric signals of Kaminsky and Reinhart, 201–3, 204–5 and market-based signals, 203–5 overview, 199–200 recommendations, 205–6 and FX hedging policy, how to develop, 175–84, 176, 179, 180, 181, 183 analysis, 176–8 background, 176 and budget rates, 181–2 company objectives, 176 and hedging products, 182 how much to hedge, 178–81 overview, 175–6 recommendations, 184 risk management approach, step by step, 176 which currencies to hedge, 182–4 managing, with dynamic option strategy, 227–37 analysis, 230 background, 229 company objectives, 229–30 overview, 227–9 recommendations, 235–7 369 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 370 — #402 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT netting, 185–98, 187, 189, 190, 191, 192, 193, 194, 195, 196, 197 analysis, 186–7 background, 186 company objectives, 186 and earnings-at-risk calculation, 190–3 and individual transaction exposures by subsidiary and currency, 189–90 overview, 185–6 recommendations, 197 step-by-step process of, 187–97 section overview, 169–72 and translation risk, managing, 215–25, 218, 219, 220, 221, 223 analysis, 217–18, 218–24, 218 background, 217 company objectives, 217 overview, 215–17 recommendations, 224 D debt duration: and cost of fixing, 71–2 and fixed–floating mix, 69–92 analysis, 70 background, 69 company objectives, 69–70 recommendations, 89–91 Fortune 500, study on, 33 optimal, via Merton’s model, 33–40, 39 analysis, 35–8 background, 35 company objectives, 35 recommendations, 39; see also funding optimisation approach, step by step, 70–89, 70 Step 1: changing treasury policy, 70–7 Step 2: reducing hedging cost, 77–9 Step 3: monitoring risk impact, 79–84 Step 4: tactical considerations, 84–9 optimisation of, versus VaR, 154–5 and perfect timing, value of, 84–7, 85, 86, 87 and possible ways to reduce hedging costs, 73–7 increasing probability of saving, 75–7 reducing duration, 74–5 reducing fixed proportion, 73–4 reduced fixed proportion, 80 strategy, current versus reduced duration, 78 strategy, current versus reduced fixed, 80 strategy, reduced duration, 79 swaption strategy, 90–1, 90 debt, inflation-linked, 107–16, 109, 111, 112, 113, 114 analysis, 109 assumptions, 111–12 background, 108–9 company objectives, 109 overview, 107–8 recommendations, 115 results, 113–14 risk management approach, step by step, 109 Step 1: quantifying interest rate and inflation risk, 110 Step 2: determining optimal liability composition, 110 strategy application, 114–15 deferred consideration, monetising, 317–21, 318, 320 analysis, 318 background, 317 company objectives, 317–18 overview, 317 pricing, 319–20 recommendations, 320 results, 318–19 370 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 371 — #403 ✐ ✐ INDEX financing SPV in capital markets, 319 optimal structure, 318–19 derivatives risks: counterparty, 61 liquidity, 61 settlement, 61 valuation, 60 derivatives scandals, rarity of, xxiii Dodd–Frank Act, xxviii dynamic hedging, limits on, 64–5 dynamic option strategy: and managing FX risk, 227–37 analysis, 230 background, 229 company objectives, 229–30 overview, 227–9 recommendations, 235–7 E emerging-market currencies, managing, 199–206 background, 200 company objectives, 201 and econometric signals of Kaminsky and Reinhart, 201–3, 204–5 and market-based signals, 203–5 overview, 199–200; see also currency risk recommendations, 205–6 equity: higher cost of, 102–4 reducing risk of, 163–4 European Market Infrastructure Regulation (EMIR) xxviii F fair-value risk, 148 fixed–floating mix and duration, improving, 69–92, 70, 71, 72, 73, 74, 75, 76, 77, 78, 79, 80, 81, 82, 83, 85, 86, 87, 88, 89, 90 analysis, 70 background, 69 company objectives, 69–70 optimisation approach, step by step, 70 see also debt duration foreign exchange (FX) risk, see currency risk forming initial rating expectations, 12–13 Fortune 500 Company list, 33 funding, 3–50 cash tender offer, 27–32 background, 27 company objectives, 28 market background, 29 results, 31 solution, 29–30 structure summary, 30–1 cost, creating single- or multi-factor model of, 47 cost drivers, 41–50, 43, 44, 45, 46, 48 analysis, 42–3 background, 42 company objectives, 42 recommendations, 48–9 step-by-step process of, 43–8, 43; see also cost drivers, funding intermediated exchange, 19–25 background, 19 company objectives, 20 execution of operation, 24 market background, 20–1 principal benefits, 22 pros and cons of different approaches, 22–3 recommendations, 23 results, 24 solution, three options, 21 step-by-step transaction structure, 23 and Merton’s model, optimal debt duration via, 33–40, 39 analysis, 35–8 background, 35 371 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 372 — #404 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT company objectives, 35 recommendations, 39 obtaining credit rating, 9–18, 10 analysis, 11–12, 11–12 background, 9–10 business profile, 13 company objectives, 10 recommendations, 18 Step 1: forming initial rating expectations, 12–13 Step 2: introductory agency meetings, 13–16 Step 3: preparing for management presentation, 16–17 and peer group analysis, 15–16 section overview, 3–7 FX risk, see currency risk H hedging costs, reducing: possible ways of achieving, 73–7, 77 simplified strategy for, 77–9, 77 hedging policy, developing, 57–68, 61, 62, 67 analysis, 58–60 methodology, 58, 58 summary, 58 background, 57 benchmarking, 66 company objectives, 57 derivatives risks, 60–1 for foreign exchange risk, 175–84, 176, 179, 180, 181, 183 analysis, 176–8 background, 176 and budget rates, 181–2 company objectives, 176 and hedging products, 182 how much to hedge, 178–81 overview, 175–6 recommendations, 184 which currencies to hedge, 182–4 for foreign exchange, risk management approach, step by step, 176–97, 176 and optimum fixed–floating mix, 66–8 performance measures, 65 processes and organisation, 60 recommendations, 68 risk management approach, step by step, 58 sector case studies, 58–60 aggressive approach, 59 conservative approach, 58–9 dynamic approach, 59 hedging uncertain exposures, 323–35, 325, 326, 327, 328, 329, 330, 331, 332, 333 analysis, 325 background, 324 company objectives, 324–5 and duration optimisation approach, step by step, 325–34 Step 1: scoring deal sensitivity to FX (transaction occurs), 325–7 Step 2: scoring unwind P&L (transaction fails), 327–8 Step 3: scoring post–hedge rate, 328–31 Step 4: applying FX distribution, 331–3 Step 5: applying deal likelihood, 334 overview, 323–4 recommendations, 334 historical analysis and peer benchmarking, 43–6 I inflation-linked debt, 107–16, 109, 111, 112, 113, 114 analysis, 109 assumptions, 111–12 background, 108–9 372 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 373 — #405 ✐ ✐ INDEX company objectives, 109 overview, 107–8 recommendations, 115 results, 113–14 risk management approach, step by step, 109 Step 1: quantifying interest rate and inflation risk, 110 Step 2: determining optimal liability composition, 110 strategy application, 114–15 initial rating expectations, forming, 12–13 interest rate and inflation risk, 53–166 and asset and liability management, 147–57, 148, 149, 151, 152, 153, 155, 156 analysis, 151–2 background, 150 overview, 147–50 recommendations, 156–7 risk management approach, step by step, 151–6 and company valuation, impact of fixed–floating policy on, 93–105, 95, 96, 98, 99, 100, 101, 103, 104 analysis, 94 and back-testing, 100 background, 94 company objectives, 94 and consensus forecasts, 98 discounted cashflow methodology, 96–7 and equity, higher cost of, 102–4 overview, 93–4 recommendations, 104 and share price, step by step, 95–104 and valuation, 98–100 and WACC calculation, 98 and constrained maturity optimisation, 141–6 analysis, 142–5 background, 141–2 company objectives, 142 recommendations, 145 and cost of fixing, 71–2 and fixed–floating mix and duration, improving, 69–92, 70, 71, 72, 73, 74, 75, 76, 77, 78, 79, 80, 81, 82, 83, 85, 86, 87, 88, 89, 90; see also debt duration analysis, 70 background, 69 company objectives, 69–70 optimisation approach, step by step, 70 and fixed–floating mix, optimum, 66–8 and hedging policy, developing, 57–68, 61, 62–3, 67 analysis, 58–60 background, 57 benchmarking, 66 company objectives, 57 derivatives risks, 60–1 dynamic, limits on, 64–5 mitigation, 62–5 performance measures, 65 processes and organisation, 60 recommendations, 68 risk management approach, step by step, 58 and inflation-linked debt, 107–16, 109, 111, 112, 113, 114 analysis, 109 assumptions, 111–12 background, 108–9 company objectives, 109 overview, 107–8 recommendations, 115 results, 113–14 risk management approach, step by step, 109 strategy application, 114–15 and possible ways to reduce hedging costs, 73–7 increasing probability of saving, 75–7 373 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 374 — #406 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT reducing duration, 74–5 reducing fixed proportion, 73–4 prehedging, 117–25, 119, 120, 124, 128, 129, 130, 131, 132, 133, 134, 135, 136, 137, 138 and accounting treatment, 122–4 analysis, 118 background, 118, 127 and bond issuance, step by step, 118–24, 119 company objectives, 118, 128 cost analysis, step by step, 129–38, 129 cost, forecasting from distance to local minimum, 134–6 cost, one into five years, 130–1 and dynamic of past swap rate hikes, 137–8 future cost, steepness as indicator of, 133–4 market background, 128–9 overview, 117–18, 127 recent cost, comparison of, 131–2 recommendations, 125, 138–9 solutions, designing, 120–1 and uncertain maturity, 124 and uncertain starting date, 124 when to, 127–39; see also prehedging section overview, 53–6 intermediated exchange, 19–25 background, 19 company objectives, 20 execution of operation, 24 market background, 20–1 principal benefits, 22 pros and cons of different approaches, 22–3 recommendations, 22–3 results, 24 solution, three options, 21 step-by-step transaction structure, 23 introductory agency meetings, 13–16 K Kaminsky and Reinhart (KR) method, 201–3, 203, 204–5 see also currency risk L liability and asset management, 147–57, 148, 149, 151, 152, 153, 155, 156 analysis, 151–2 assumptions, 151–2, 152 methodology, 151 background, 150 overview, 147–50 recommendations, 156–7 risk management approach, step by step, 151 Step 1: optimising fixed–floating mix versus VaR, 153–4 Step 2: optimising duration versus VaR, 154–5 Step 3: evaluating cashflow-at-risk impact, 155–6 liability and asset management, pension funds, 159–66, 160, 161, 162, 163, 164, 165, 166 analysis, 160 background, 159–60 company objectives, 160 and equity risk, reducing, 163–4 and interest rate risk, reducing, 163 overview, 159 recommendations, 164 risk management approach, step by step, 160–4, 160 374 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 375 — #407 ✐ ✐ INDEX Step 1: calculating asset and liability sensitivities and distribution, 160–2 Step 2: determining breakdown of risk to surplus by asset class, 162 Step 3: exploring ways to reduce risk to the surplus, 163–4 M M&A risk: and bond documentation, 313–16, 315 analysis, 314 background, 313 company objectives, 313–14 consent solicitation overview, 314–15 overview, 313 recommendations, 315–16 results and outcome, 316 and deferred consideration, monetising, 317–21, 318, 320 analysis, 318 background, 317 company objectives, 317–18 overview, 317 pricing, 319–20 recommendations, 320 results, 318–19 and hedging uncertain exposures, 323–35, 325, 326, 327, 328, 329, 330, 331, 332, 333 analysis, 325 background, 324 company objectives, 324–5 and duration optimisation approach, step by step, 325 overview, 323–4 recommendations, 334 management for, 299–311, 301, 303, 304, 305, 306, 308 analysis, 300–2 background, 299–300 capital structure, 303–7 company objectives, 300 currency cashflow mix, 303 deal parameters and timelines, 300–1 financials: assuming all-debt financed, 303 optimal debt structure, 307 overview, 299 recommendations, 310 and total debt, optimal currency split of, 307–9 understanding transaction, 300 and rating impact of an acquisition, 293–8, 295 analysis, 294 background, 293 company objectives, 294 overview, 293 recommendations, 297 risk management approach, step by step, see rating impact of an acquisition section overview, 287–91 event-specific, 288 Step 1: rating impact of an acquisition, 289; see also M&A risk: and rating impact of an acquisition Step 2: addressing ALM considerations, 290 Step 3: finding optimal debt composition, 290–1 Step 4: assessing risk and finding hedging solution, 291 strategic, 287–8 transforming, 288 uncertainty, 288–9 sources of, 309 management presentation, preparing for, 16–17 Markets in Financial Instruments Directive (MiFID) Review, xxviii 375 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 376 — #408 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT mathematical assumptions and required knowledge, xxv–xxvi maturity optimisation, constrained, 141–6 analysis, 142–5 methodology, 143–5 company objectives, 142 recommendations, 145 mergers and acquisitions, risks related to, see M&A risk Merton’s model, optimal debt duration via, 33–40, 39 analysis, 35–8, 38 of debt structure, 37–8 background, 35 company objectives, 35 generalisation, 35–6 illustration of, 37 recommendations, 39; see also funding monetising deferred consideration, 317–21, 318, 320 analysis, 318 background, 317 company objectives, 317–18 overview, 317 pricing, 319–20 recommendations, 320 results, 318–19 financing SPV in capital markets, 319 optimal structure, 318–19 N netting FX risk, 185–98, 187, 189, 190, 191, 192, 193, 194, 195, 196, 197 analysis, 186–7 background, 186 company objectives, 186 and earnings-at-risk calculation, 190–3 and individual transaction exposures by subsidiary and currency, 189–90 overview, 185–6 recommendations, 197 step-by-step process of, 187–97 Step 1: evaluating net economic risk to the group via an EaR measure, 187–93 Step 2: separating between transactional and economic exposures, 193–5 Step 3: looking for offsets between two sets of exposures and proposing residual hedge, 195–7 new bonds, three main questions concerning, 41 O obtaining credit rating, 9–18 analysis, 11–12, 11–12 company objectives, 10 introductory agency meetings, 13–16 and peer group analysis, 15–16 recommendations, 18 step-by-step process of, 10 Step 1: forming initial rating expectations, 12–13 Step 2: introductory agency meetings, 12–13 Step 3: preparing for management presentation, 16–17 see also funding optimal deposit composition, 263–76, 265, 268, 269, 270, 271, 272, 273, 274, 275 analysis, 264 applied to derivatives exposure, 274–6 background, 263–4 company objectives, 264 overview, 263 recommendations, 274 step by step, 264–74, 265 376 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 377 — #409 ✐ ✐ INDEX Step 1: simplified conservative model, 264–7 Step 2: full conservative model, 268–71, 268, 270 Step 3: strategic model, 271–4 P peer benchmarking and historical analysis, 43–6 peer group analysis, 15–16 pension funds: asset and liability management for, 159–66, 160, 161, 162, 163, 164, 165, 166 analysis, 160 background, 159–60 company objectives, 160 and equity risk, reducing, 163–4 and interest rate risk, reducing, 163 overview, 159 recommendations, 164 risk management approach, step by step, 160–4, 160 Step 1: calculating asset and liability sensitivities and distribution, 160–2 Step 2: determining breakdown of risk to surplus by asset class, 162 Step 3: exploring ways to reduce risk to the surplus, 163–4 prehedging credit risk, 277–83, 279, 281, 282 analysis, 278–9 background, 277–8 call spread, 281–2, 282 company objectives, 278 hedging strategy, 280 overview, 277 recommendations, 282–3 straight call, 280–1, 281 prehedging interest rate and inflation risk, 117–25, 119, 120, 124 and accounting treatment, 122–4 analysis, 118 background, 118 and bond issuance, step by step, 118–24 Step 1: deciding whether or not to hedge, 118–20 Step 2: designing solution, 120–4 Step 3: testing flexibility of solution, 124 company objectives, 118 overview, 117–18 recommendation, 125 solutions, designing, 120–1 and uncertain maturity, 124 and uncertain starting date, 124 prehedging, when to, 127–39, 128, 129, 130, 131, 132, 133, 134, 135, 136, 137, 138 background, 127 company objectives, 128 cost analysis, step by step, 129–38, 129 Step 1: defining measure for prehedging cost, 130 Step 2: estimating historical prehedging cost, 130–2 Step 3: finding moments when prehedging cost is lowered, 133–6 Step 4: tactical considerations, 136–8 cost, forecasting from distance to local minimum, 134–6 cost, one into five years, 130–1 and dynamic of past swap rate hikes, 137–8 future cost, steepness as indicator of, 133–4 market background, 128–9 overview, 127 377 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 378 — #410 ✐ ✐ THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT recent cost, comparison of, 131–2 recommendations, 138–9 preparing for management presentation, 16–17 R rating impact of an acquisition, 293–8, 295 analysis, 294 background, 293 company objectives, 294 overview, 293 recommendations, 297 risk management approach, step by step, 294 Step 1: assessing business profile, 294–5 Step 2: peer group analysis, 296–7 Step 3: assessing execution-related issues, 297 risk: cashflow, 148 commodity, 339–59 and commodity-linked revenues and currency risk, 345–52 section overview, 339–43 cost versus, on liability side, 148 counterparty, 61 credit, 241–83; see also credit risk and counterparty risk methodology, 245–53 and optimal deposit composition, 263–76; see also main entry section overview, 241–3 currency, see currency risk derivatives, 60–1 fair-value, 148 foreign exchange, see currency risk interest rate and inflation, see interest rate and inflation risk liquidity, 61 M&A-related, see M&A risk roles and responsibilities for management of, 61 settlement, 61 structural, 170 to surplus, determining breakdown of by asset class, 162 transaction, 171, 187–8, 299 translation, 170–1, 187, 299 translation, managing, 215–25, 218, 219, 220, 221, 223 analysis, 217–18, 218–24, 218 background, 217 company objectives, 217 overview, 215–17 recommendations, 224 valuation, 60 ways of mitigating, 62–5 risk management approach, step by step, to surplus, exploring ways to reduce, 163–4 risk management performance, benchmarking of, xxiv–xxv risk management roles and responsibilities, 61 S structural risk, 170 swaptions: Bermudan, 121 for floating debt, 90–1 strategy for, 90 T transaction risk, 171, 187–8 FX, 299 translation risk, 170–1, 187 FX, 299 managing, 215–25, 218, 219, 220, 221, 223 378 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 379 — #411 ✐ ✐ INDEX analysis, 217–18 background, 217 company objectives, 217 overview, 215–17 recommendations, 224 risk management approach, step by step, 217–18 Step 1: defining scope of analysis, 218–19 Step 2: simulating market variables, 220 Step 3: determining efficient frontier, 221–4 Step 4: tactical considerations, 224 and duration optimisation approach, step by step, 325–34 Step 1: scoring deal sensitivity to FX (transaction occurs), 325–7 Step 2: scoring unwind P&L (transaction fails), 327–8 Step 3: scoring post–hedge rate, 328–31 Step 4: applying FX distribution, 331–3 Step 5: applying deal likelihood, 334 overview, 323–4 recommendations, 334 U V uncertain exposures, hedging, 323–35, 325, 326, 327, 328, 329, 330, 331, 332, 333 analysis, 325 background, 324 company objectives, 324–5 value-at-risk (VaR): and duration, optimisation of, 154–5 limitations of, xxvi–xxvii scenario analysis, including duration split, 155 379 ✐ ✐ ✐ ✐ ✐ ✐ “myint” — 2012/10/18 — 17:47 — page 380 — #412 ✐ ✐ ✐ ✐ ✐ ✐ ... THE HANDBOOK OF CORPORATE FINANCIAL RISK MANAGEMENT while its production is predominantly in EUR This exposes the company to currency risk Annual currency volatility is of the order of 15%; therefore,... illuminate the subject of risk for anyone who is touched by the issue of corporate risk management If, in these troubled times, we have helped clarify and even reduce financial risk for just a few of. .. several hundred of the largest European corporations from all industrial sectors.1 Its subject is corporate financial risk management, ie, the management of financial risks for non -financial corporations