Click to edit. style. Tom Tsaganos Speaker VP, Commercial Bank Foreign Exchange. Lisa Spano Speaker VP, Treasury Services, Trade Finance and Logistics

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1 Sept / Oct 2007 T R E A S U R Y & S E C U R I T I E S S E R V I C E S Click to edit Solutions to Help You Execute: A Discussion Master with title Experts in Foreign Exchange and Trade style Charles Darwall Moderator VP, International Product Sales Specialist Lisa Spano Speaker VP, Treasury Services, Trade Finance and Logistics Tom Tsaganos Speaker VP, Commercial Bank Foreign Exchange

2 This presentation was prepared exclusively for the benefit and internal use of the JPMorgan Chase client to whom it is directly addressed and delivered (including such client s subsidiaries, the Company ) in order to assist the Company in evaluating, on a preliminary basis, certain products or services that may be provided by JPMorgan Chase. This presentation contains information which is confidential and proprietary to JPMorgan Chase, which may only be used in order to evaluate the products and services described herein and may not be disclosed to any other person. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources or which was provided to us by or on behalf of the Company or which was otherwise reviewed by us. This presentation is for discussion purposes only and is incomplete without reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan Chase. Neither this presentation nor any of its contents may be used for any other purpose without the prior written consent of JPMorgan Chase. JPMorgan Chase makes no representations as to the legal, regulatory, tax or accounting implications of the matters referred to in this presentation. Notwithstanding anything in this presentation to the contrary, the statements in this presentation are not intended to be legally binding. Any products, services, terms or other matters described in this presentation (other than in respect of confidentiality) are subject to the terms of separate legally binding documentation and/or are subject to change without notice. Neither JPMorgan Chase nor any of its directors, officers, employees or agents shall incur any responsibility or liability whatsoever to the Company or any other party in respect of the contents of this presentation or any matters referred to in, or discussed as a result of, this document. JPMorgan Chase is a marketing name for treasury services businesses of JPMorgan Chase Bank, N.A., and its subsidiaries worldwide. JPMorgan Chase is licensed under U.S. Pat. Nos. 5,910,988 and 6,032, JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 1 1

3 Introduction today s speakers Charles Darwall Moderator Lisa Spano Trade Finance Managing commercial and political payment risks Financing of international trade Tom Tsaganos Foreign Exchange Defining foreign exchange risk Identifying where FX risk resides 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 2 2

4 Who bears the payment risk in a trade transaction? Buyer s risk Seller s risk Prepayment Letter of Credit Documentary Collection Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 3 3

5 Who bears the payment risk in a trade transaction? Prepayment: Seller demands receipt of of payment before shipping the the goods. The The seller assumes no no payment risk, risk, at at the the expense of of the the buyer. Prepayment Letter of Credit Documentary Collection Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 4 4

6 Who bears the payment risk in a trade transaction? Letter of of Credit: Buyer issues a letter of of credit to to the the seller through his his bank. Seller ships the the goods and and submits title title and and shipping documents to to his his bank for for presentation to to the the buyer s bank. Buyer s bank automatically pays pays the the seller if if all all conditions of of the the letter of of credit are are met. Buyer s bank must pay pay seller if if all all conditions are are met met even if if the the buyer is is not not able able to to pay. pay. Prepayment Letter of Credit Documentary Collection Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 5 5

7 Parts of the world where Letters of Credit is the most common method of international trade 90%+ Letter of Credit 50% Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 6 6

8 Who bears the payment risk in a trade transaction? Documentary Collections: Seller ships goods and and submits title title and and shipping documents to to the the buyer s bank. The The bank surrenders the the documents to to the the buyer against receipt of of payment or or acceptance of of a draft. Similar to to cash cash on on delivery (COD) using a bank The The buyer s bank does does not notguarantee payment Prepayment Letter of Credit Documentary Collection Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 7 7

9 Who bears the payment risk in a trade transaction? Open Account: Seller ships the the goods and and waits for for payment directly from the the buyer based on on prescribed repayment terms, such such as as net net days. The The seller assumes the the buyer s (commercial and and political) payment risk risk Prepayment Letter of Credit Documentary Collection Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 8 8

10 Parts of the world where Open Account is the most common method of international trade 90%+ Open Account 50% Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 9 9

11 Who bears the payment risk in a trade transaction? Buyer's risk Seller s risk Prepayment Letter of Credit Documentary Collection Open Account 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 10 10

12 You can not do business in these countries, under federal OFAC statutes Cuba Iran Iraq Liberia Libya Myanmar N.Korea Sudan Syria Zimbabwe OFAC = Office of Foreign Assets Control 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 11 11

13 Foreign exchange risk arises from all international business flows EXPORT SALES Receivables IMPORT SALES Payables INTERCOMPANY TRANSACTIONS ACQUISITIONS DIVESTITURES Loans, Dividends, Royalties, Franchise Fees 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 12 12

14 The risk to U.S. importers that price in USD is increased costs / decreased margins For U.S. importers that price in USD, the risk is increased costs & decreased margins If USD weakens relative to the supplier s local currency, the vendor may increase prices in dollar terms in order to protect profit margins This price increase translates to higher costs and/or decreased margins for the U.S. importer Conversely, in times of dollar strength, the U.S. importer is unlikely to receive price breaks from overseas vendors This situation of greater risk than reward is highly undesirable Asymmetric risk/reward can be mitigated by the U.S. importer choosing to pay in local currency and hedge its currency risk USD Weakens Versus Foreign Currency Foreign Currency Revenues to Foreign Vendor Decreases Foreign Vendor Increases USD Prices to Protect Margins U.S. Importer s Profits Decrease with Increased Cost 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 13 13

15 The risk to U.S. exporters that price in USD terms is reduced sales For U.S. exporters that price in USD, the risk is decreased sales If USD strengthens versus the customer s local currency, a static USD price translates to increased COGS for the foreign customer This increase may drive customers to buy from competitors U.S. exporters can mitigate this risk by pricing in local currency and hedging the USD value of foreign revenues in order to keep sales at attractive levels USD Strengthens versus Foreign Currency Cost to Foreign Customer Increases Foreign Customer Reduces Orders due to Decreased Profitability U.S. Exporter s Total Profits Decrease with Sales 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 14 14

16 Assessing FX risk requires delineation of the types of FX risk Transactional Risk Transactions denominated in a foreign currency are settled at a different exchange rate then they were initially recorded at or subsequently revalued to Translational Risk Translation of foreign currency denominated balance sheet and income statement items Firm Value Economic Risk Competitive advantages and or disadvantages resulting from exchange rate fluctuations 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 15 15

17 Hedging approaches forecast risk, transaction risk, translation risk Companies have varying approaches with regard to the foreign currency exposures they hedge. Broadly speaking companies that hedge foreign currency exposures fall into three categories: Forecast Risk Transaction Risk Translation Risk Budget Sale/Expense Cash flow Translation at consolidation Client Group I - Manage FX exposure from recognition to cash flow Client Group II - Manage FX exposure from budget to cash flow Client Group III - Manage FX exposure from budget to consolidation 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 16 16

18 Why deal in foreign currency? Save money Eliminate the hidden cost and market-fluctuation markups that can accompany foreign bills or invoices quoted in U.S. dollars. JPMorgan encourages clients to ask for both the foreign currency and U.S. dollar payment amounts to see the potential savings Save time Your international payments will be sent to the designated foreign bank within two business days via SWIFT. Gain competitive advantage You may be able to negotiate a better price with your overseas business partner when they avoid assuming the risks of currency rate fluctuations Reduce risk On the day you make your foreign payment, JPMorgan locks in the exchange rate: this means you know your exact cost in U.S. dollars, and you are protected against further currency fluctuations 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 17 17

19 Spot contract Spot Contract is the exchange of one currency for another. The spot rate is the current market price. These transactions do not require immediate settlement or payment. The settlement date is the second business day after the date of the transaction. The benefit to using this type of transaction is that business owners know the exact amount of USD that is needed and the payments are timely JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 18 18

20 Countries of the world where spot trading is allowed Spot Trading allowed Spot Trading disallowed There are many countries that only allow the onshore sale of their currency for a more exact list please contact us JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 19 19

21 Forward contracts Forward Contract is the purchase or sale of one currency for another but is settled on any pre-agreed date three or more business days after the deal date. If the delivery date is not know, window forwards allow the flexibility of taking delivery within a period of time. These transactions can be used to cover a known future non-usd expenditure in order to lock in the cost of goods. The business is protected from possible negative exchange rate moves. Non-Deliverable Forward - the Non-Deliverable Forward contract (NDF) is a contract that, like the a traditional over-the-counter forward, establishes a forward exchange rate between two currencies for a forward date. Unlike the traditional contract, the NDF does not result in an exchange of principle amounts at maturity. Instead, a benchmark exchange rate is referred to at maturity and compared to the rate on the contract to determine a settlement amount that is denominated in U.S. dollars. This allows you to hedge the FX exposure, and is frequently used in countries where the convertibility of the currency is restricted JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 20 20

22 Countries of the world where forward trading is allowed No Trading Allowed Vanilla Forwards Non-Deliverable Forwards 2007 JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 21 21

23 Currency option contract Currency Option Contract was developed to address a lack of flexibility in forward contracts. For a fee, you can buy the right - but not the obligation - to buy a currency at a fixed price on or before an agreed upon future date. The agreed upon price is called the strike price. Generally, an option is exercised at maturity if it is in the money and expires without value if the option is out of the money. Using an option contract allows you to know the maximum future cost of imported goods because the option strike price ensures that you will not pay more than the strike price. Further, you can protect your operating margin from further FX volatility risk JPMorgan Chase & Co. All rights reserved. JPMorgan Chase Bank, N.A. Member FDIC 22 22

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