This book develops and presents in an easily comprehensible way the essential elements of a corporate strategy for managing uncertainty in the macroeconomic environment. This Macroeconomic Uncertainty Strategy – MUST – enhances firm value by allowing management and external stakeholders to distinguish between changes in the intrinsic competitiveness of the firm and changes in performance caused by macroeconomic fluctuations. These fluctuations - manifested as changes in exchange rates, interest rates and inflation rates - are beyond management’s control but they have a substantial impact on performance.
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Index
A Bankruptcy cost 38,43,47
Accounting exposure 62, 69-70, 83, 166 Barnea, A. 137
Accounting for hedge contract 189 Bartov, E. 120
Accounting measure 31,52,60,67,196 Beaver W.H. 235-236
Accounting net worth 167 Benchmarking 13,49,231,258-259
Accounting risk 31 Best-case scenario 13
Accounting Standard Committee (ASC) 235 Bhandari, J.S. 123
Accounting standard 62, 64, Bid-ask spread 164, 208
189, 232, 234-235, 238 Bierman, H. 236
Accounting translation exposure 62 Bilateral measurement 89, 92
Accounting value 66,73,99, 263 BMW 134-135
Accounting-based exposure measure 192 Bodnar, G.M. 120
Accounting-based performance measure 214 Bonds 34,172,184,206
Accounts payable 53, 59, 104 Bonus system 10, 214, 216, 223
Accounts receivable 53, 59, 104 Book value 31,36-37,63,66-67,
Adams, J.B. 189 70, 72, 127, 195
Adjustment cost 35, 128,225 Boyd, W. 87
Adler,M. 98,123 Bretton Woods 17, 234
Advance payment 158 Bromwich, M. 236
After-tax translation gain 168 Budget 70, 111, 113, 128-129,
Aggregate demand 15, 18, 40, 73, 139, 230, 26o, 262
105-106, 220, 241 Budgeting decision 230
Agreement 225, 234 Business condition 16,111,206
Aliber,R2. 235,236,241 Business risk 31,255
All-current (AC) method 65, 67, Business-cycle 39
82, 83, 86
Arnihud, Y. 120 C
Annual report 13,62,121,128,135,137, Call option 47,159,162-163,
147-148, 154, 243-244, 247, 255 185-187,224
Anticipated cash flow 70, 220 Campbell J.Y. 122.
Anticipated change 29, 224 Canadian Institute of Chartered
Arbitrage opportunity 34 Accountants (CICA) 235
Audi 21, 135 Cape1 J.J. 46,213,230
Autocorrelation 130 Capital mobility 11,22
Automotive industry 243,247,256 Capital stock 18
Car manufacturer 21,64,135-I36,
B 139,142
Balance sheet value 166 Cash flow effect 15-16, 106, 112-113,
Balance sheet 53,62,65-67,70,81, 125,143-I45,148,154, 178-179,
83-84,165-166,238,267 217-218, 225-227, 229
Bank loan 34 Cash Flow at risk (CFaR) 77, 259-260
Bank of international settlements (BIS) Cash flow decomposition 218
31-32 Cash flow exposure 26,52-53,59-62,
Bankruptcy 34,36-38,46,76, 67-70, 72, 100-101, 104,108-109,
196-199,260 118-119, 137,152, 175, 186,199, 205
282 Index
Cash Flow Return on Investment (CFROI) Costs of goods sold 65, 101,
214, 228 104-105, 229
CEO's letter to shareholder 243 Country risk 33,39-40
Character of shock and disturbance 23 Cover 50, 156-157, 159, 161-164, 175,
Cheap credit 173 191-192,194
Choi, H. 235-236 Craig, R. 237
Chrysler 256 Credit assessment 196
Clark, F 237 Credit line 31
Coefficient of sensivity 71-72, 77, 80, Credit risk 31-32
125 129-130,139,145,I54,217, Credit term 41,211
227, 238, 240, 242, 244, 250, Currency basket 91, 172
254, 259-260, 264-265 Currency composition 73, 121, 125, 137
Coefficient stability 130 Currency denomination 29,34,39,41,
Commercial cash flow 53,59-61,77, 59, 63, 79, 94, 98, 100, 118-119, 125,
100,119,121-122,129,137,140- 128, 146-147, 153, 157, 165, 173,
141,143-148,174-175,177-178, 181, 201,204-205, 212
182,199,205,208 Currency of invoice 41
Commercial exposure 56,72,77,121, Currency reserve 158
129,137,19I,202,208,211-212,236 Currency risk 39-40,94-95,98
Commercial operation 21, 31, 35, 58, Current rate 64-65, 70, 82
70,72-73, 132, 143, 157, Customer loyalty 48
174, 191-192, 200-201, 204,
2o6,208-212 D
Commercial risk 19,31-33,40,259 Daimler Chrysler 256
Commodity arbitrage 89-90 Debt-holder 34, 38, 50
Commodity price index 179 Debt repayment problem 18
Commodity price risk 179 Degree of adjustability 73
Compensation scheme 16,36,223 Demand elasticity 142
Competitive position 13,20,58-6o,91, Dempsey, S J. 237
93,107,135,192, 214,219 Depreciation 58,61,65,84,113-114,
Competitiveness 11, 12, 14, 26-27, 80, 130, 137, 147, 151-152, 154, 219,
91-92, 99-100, 142, 209, 216, 223, 225,250,252
232, 240,247,253,258,265 Dillard, J. 234
Conflict of interest 193 Discount rate 33,44,71,196
Consolidated balance sheet 62 Discounted Cash Flow (DCF) 214,216
Consumer price 90-91, 140 Disinvestment 46
Consumption pattern 90 Dixit, A. 230
Contracted payment 52 Domestic inflation 49
Contractual exposure 53,267 Domestic interest rate 49, 114
Contractual flexibility 225 Domestic market 6o, 107, 201-202
Corporate law 36 Downside risk 30,187
Corporate performance 11, 13, 26, 28, Dufey, G. 241
215, 237, 234, 240-241, 243-244, Dukes, R. 67, 234
252-253, 255, 257-258,260 Dumas, B. 98, 123
Corporate risk 28-29,33,49 Duration 16,73,75-77,229
Corporate tax 36 DEM 21-22, 139, 142, 145, 149-150,
Cost factors 40 153,185
Cost of capital 72,80,198 Demand condition 11,35,40,72,224
Cost of debt 78 Debt 18,21,34,38,42-43,50,78-79,
Cost-benefit analysis 43, 49-50 92, 107, 110, 137, 146-148, 153, 157,
Costs of consultant 44 165,172,205,236
Index 283
E EVA 13,27,214,228-229,254,259
Earnings stability 34 EMU 11, 14, 18
Economic exposure 12-14, 16, 23, Expected return 19, 33-34, 94, 161,
25-26, 44, 51-99, 129-193, 197, 201, 212
212, 159
Economic measure 52, 59-60 F
Economic performance 31 Factoring 158
Economic Value Added (EVA) 13, 27, Factory ship 46
214, 228-229, 254, 259 False hedging 169-170
Economic value exposure 51,60-62, Fama,E.E 122, 198
68,71 Federal reserve 16-17
Efficient financial market 33, 36,99, Filtered profit 49
163-164,188 Filtering method 228
Einzig, P. 86 Financial Accounting Standards Board
Electrolux 219-222, 225,227-228 (FASB) 63-65, 67, 82, 234-236, 247
Employees 34-36, 43, 49, 134, 184, Financial and economic integration 14,
200,217,258 232
Employment level 43 Financial cash flows 68,71,102,104,
Equity 20,34,43,50,66,78,83,85-86, 118, 122, 139, 145, 260, 263, 266
148, 189-190, 218, 223, 231, 254 Financial contracts 41, 100-101, 153,
Equity index 20 181,209,268
Equity issue 37 Financial department 53
Eurc, 18, 93, 250-252 Financial exposure 31, 56, 61, 145, 191,
Eurobond market 11 213
European Monetary System (EMS) 17 Financial exposure management 145
European Monetary Union 14,18 Financial institutions 74, 157, 202, 254
Evans, P. 234 Financial instrument 20,26,45,117,
Exchange control 95, 160-161, 266 121,153,160,190,193,209,
Exchange rate exposure 19, 51-52, 65, 235-236,260
67,70-73,80,101,105,107-109,116, Financial market 11, 18-19,31,33-34,
126,144-146,156,174-175,178,181, 41, 51, 72, 95, 107, 135, 144, 153,
200-201,204,233, 264,287 161, 164, 174, 181, 191,195-196,
Exchange rate realignment 17,131 200-202,204,208,212,238,251,
Exchange rate regime 14,16,88,261 263,266
Exchange rate risk 14, 19, 39-41, 120, Financial risk 31, 33, 170, 196
123, 127, 174-I75, 200, 209, 224, 264 Financial structure 119, 128-129,
Exchange rate variability 40 137,146,148,212
Exercise price 45, 47-48 Firm-specific factor 23
Expected bankruptcy cost 43 Fiscal authority 40
Expected cash flow 44, 68, 70, 108, 111, Fiscal deficit 17, 114
113,129,168,186,201,216 Fiscal policy 17, 79, 111, 114, 116, 124
Expected exchange rate change 41, Fixed exchange rate 17-18,172
94-97 Fixed rate loan 173, 204
Expected inflation rate 41, 206 Flexible exchange rate 51, 78,144
Export financing arrangement 158 Flexible interest rate 146
Export price index 90-91 Floating rate 152, 154, 173
Export-oriented firm 12 Folks, M. 234
Exposure management strategy Ford 133-134
21-22,194,199,202,208,211 Forecasting 16, 29, 98, 143,204,
Exposure management tool 59, 211 206, 208, 251
External hedging 22 Foreign competitor 61
External reporting 154,232,243, Foreign currency flows 60
254-255,258
284 index
Foreign currency payment 44, 164 Implicit index 90
Foreign direct investment decision 46 Income statement 65-67, 84-85,
Foreign interest rate 19, 113, 132 137,190
Forward contract 41, 44, 48, 59, 137, Index category 90-91
152, 157, 159-160, 162-170, 176, Indexation 153, 184, 204, 264
178, 181, 184-188, 205, 267 Industry-relative price 140-141
Forward cover 159, 162-164 Industry-specific risk 39
Forward exchange rate 44, 95 Inflation differential 42, 109, 145
Forward market 21, 107, 145, 153, Inflation exposure 70, 80, 109, 145, 148,
160-162, 164-165, 169, 176, 186, 197 174-175,182,184,202,204,259,264
Francis, J. 236 Inflation rate 14, 16-20, 29, 39-42,
Frenkel J. 86 78-80, 88, 108-109, 116, 124, 140,
Functional currency 63-65, 98 142, 148, 172, 175, 184, 202, 206,
Funding cost 43 220, 225, 232, 235, 241, 259-260
Fund-raising cost 34 Inflation risk 39, 79, 104, 170, 172,
Future receivable 158 174-175,18I-183,202
Inflation-linked (indexed) bond 184
G Inflation-linked security 184, 202, 206
GAAP 154 Information cost 33
Gamma 180 Information gap 231
Garner, K. 98 Information release 233, 240, 250,
GDP 15, 241 254-255
Genberg, H. 123 Information requirement 195-196, 206,
General Motors 134 208,212,264
Geske, R. l23 Insurance policy 39
GNP deflator 90-91 Interest payment 74, 137, 174
Goods market 201 Interest rate differential 41, 94-98, 149,
Goodwin,T. 123 151,154
Gow, I.D. 228 Interest rate exposure 175, 178,
Government authority 36,49,258 181-183, 202, 204, 206
Gundy 212 Interest rate exposure measure 51,
72-73,77,80
H Interest rate futures contract 170, 172,
Hedge contract 104, 151, 153-154, 174-175
156,168-169,175-183,185-187, Interest Rate Parity (IRP) 95, 161-162,
189-191,193 164
Hedging decision 50, 80, 121, 259 Interest rate risk 38, 74, 76, 79, 127,
Hedging operation 107,125,239 171-172, 174, 182-183, 202, 204,
Historical rate 64-65, 67 206,259
Hodder, J.E. 98 Interest rate swap 171-173,181
Holders of the firm's debt 34 Internal control 32
Home jurisdiction 235 Internal evaluation 199
Home market price 58 Internal pricing routine 158
Hostile take-over 43 International Accounting Standards Com-
Huefner, R.J. 235 mittee(IASC) 189,232.,235,240
Hunt, H.G. 237 International Fisher Parity (IFP) 19, 41,
78,94-95,97-98,161,163-164,170,
I 201-208,241,255,264,266
IASC (International Accounting Standards Intra-EMU transaction 14
Committee) 189, 232, 235, 240 Intrinsic growth 252
Ibrahimi, F 123 Intrinsic level of cash flows 217
Ijiri, Y. 235 Inventory cost 35
Index 285
Investment strategy 52 Macro shock 70, 43, 131, 225
Invoice currency 53,59,268 Macroeconomic exposure 11-14, 16,
Irreversible cost 14, 210 23, 25-26,51-99,129-193,197,
212, 259
J Macroeconomic fluctuation 13, 20, 23,
Jilling, M. 134 28, 49, 80, 120, 197, 214-222, 230,
Job security 35-36, 38, 43, 149, 200 233, 240, 241, 253-254
Jorion, P. 89, 120, 122-123 Macroeconomic risk 14, 19, 24-28,
39-40, 49-50, 154, 184, 233, 255
K Macroeconomic scenario 107,117,125,
Keim, D.B. 123 143, 252-253,265
Kennedy, C. 236 Macroeconomic shock 14, 100-101,
Ketz, E. 235 104, 111, 114-116, 127, 143-144,
Keynes, J.M. 88 227,241,257-258
KLM 20 Macroeconomic Uncertainty Stra-
Kulatilaka, N. 46, 210 tegy (MUST) 12, 24-25, 27, 78, 80,
215-216, 227, 233-234, 240, 242,
L 251,254-255,257,259-260,262,
Labour cost 23, 61, 90-91, 197, 210 264-268
Labour force 18 Macro-generated profit opportunity 19
Lagged exchange rate change 120 Madden, B.J. 228
Largay, J.A. 235 Mahdavi, S. 235
Law of One Price (LOP) 19, 87, 20 Makar J.D. 235-236
Leaning against the wind 152,155 Management objective 34, 45, 126, 195
Learning mechanism 95 Managerial compensation scheme 26
Leasing 158 Market equilibrium relation 17, 19
Legal expertise 44 Market participant 36,41,67,164
Legal risk 31-32 Market price 19,31,35,41,58,72,92,
Lenders 39, 49, 79, 172, 258 109, 111-118, 121-122,124,131,
Lessard, D.R. 22,122,230 139,143,163,175,177,179,181,
Level of aggregation 100, 118, 130 190,195,206,208,260
Liability 31-32, 34-35, 50, 64-66, 73- Market risk 20, 31
77, 80, 100,119, 121, 125, 128,137, Market risk premium 20
146,161,164-66,168,173-174, Market share 64, 92,103,177,210
189-190, 193, 212,218, 234-235,259 Market valuation 67, 120, 190
Lightstone, B. 122 Market Value Added (MVA) 13, 27, 215
Lim, D. 138 Marketing effort 48
Linear decomposition of cash flows 225 Mark-up pricing strategy 101-103,
Liquidity 31-32, 37, 43, 199 105-106
Long-term contract 35 Marston, R.C. 103
Long-term debt 78-79,137,146-148, Maturity gap 73-74
153, 157, 165,172, 205 Maturity of debt 78
Long-term fixed interest rate 171 Maturity preference 79
Long-term intrinsic profit 258 McCormick,J. 228
Lorange, P. 230 McNown, R. 235
Loss of reputation 47 Mercedes Benz 135,256
Milgrom, R. 228
M Miller, M. 213
MacDonald, R. 95 Mismatch of maturity 166
Macro policy change I14, 116-118, Mitsubishi 133-134
121,124 Modified duration 73, 75-77
286 index
Monetary policy 15-18, 38, 105,241 P
Monetary shocks 11,16 P/E ratio 13,215
Money market cover 162,164 Pass-through 58,211
Money supply growth target 16-17 Pattern of pay-off 188
Money supply target 17 Payment profile 163
Montesi, J. 189 Pegged exchange rate 17, 145-146
Multilateral measurement 89, 92 Performance analysis 26, 238, 260
Multinational corporation 62 Performance assessment 216, 222-227,
Murdoch, R. z34 268
MUST-analysis 78, 80, 215-216, Performance measure 49, 214-2I5,
227,233-234,240, 241, 251, 224, 226-228, 258-259
254-255,257-268 Performance measurement 26, 223, 225
MVA 13, 27, 215 Permanent shock 118
Peso-problem 149, 151, 155
N Peterson, S. 236
Near-term cash flows 60,196, 263 Pigott, C. 89
Nominal exchange rate 111,142,235, Pindyck, R.S. 123, 230
241-242 Policy reaction 16
Nominal interest rate change 42 Policy regime 23, 40, 130-131
Non-contractual exposure 31-32,259 Policy-generated macroeconomic distur-
Non-financial firm 31-33,271 bance 15
Non-indexed loan 79 Policy-generated shock 17-18
Non-policy-generated macroeconomic Political regime 40
disturbance 15 Political risk 16,40,95,130,160,
Non-policy-generated shock 16, 18 235-237,242,261-262
Non-quantitative response 239 Portfolio return 30
Non-traded good 89-91 Portfolio risk 33,38
Prakash, P. 236
0 Predictability of cash flows 43
O'Byrne, S. 229 Present value 4,1, 60, 65, 68, 70,
Oil price change 228,260 74-75, 108, 168, 193, 197-198,
Open economy model 229 216,224
Operational decision 24, 129, 194 Price and quantity effect 53, 58-61, 71,
Operational department 53 73, 80, 98, 107, 261
Operations risk 31-32 Price earnings (p/e) ratio 13, 215
Opportunity cost analysis 50 Price uncertainty 48, 196
Option contract 47, 160, 179 Price-sensitive market segment 21
Option theory 45 Pricing of risk 41
Option value 180 Pricing Policy 36
Options cover 163 Pricing strategy 13, 48, 58, 63, 101-
Options in swap 174 102,105-107,125,128,135,211
Options pricing 45-46, 209 Probability of bankruptcy 37-38,76,
Out-of-sample evaluation 135,155 196-199,260
Out-of-sample period 151,155, Probability of default 34,36
220, 222 Probability of ruin 34, 37-38, 43,76
Output fluctuation 35 Producer price index 90-91, 140, 145
Output level 35, 200 Production costs 21-22, 102-103, 106
Outside shareholder 232-234,241, Production level 35
247, 250 252-255 Production site 21-22, 134, 200,
Oxelheim, L. 12, 22, 94-95, 112, 122, 209,224
155, 193, 198, 211, 228, 230, 233, Production volume 21, 224
235-236, 241, 255, 261 Productivity 18, 40, 105
index 287
Profit opportunity 19, 31, 78, 81, 100, Risk-aversion 36-37, 48, 186, 196,
171,187,195,204,208,210,212 198-199
Profitability 28, 61, 152, 154,201, Risk-free rate 205
209-210,254 Risk-neutral 33-35, 128, 163-164,
Project evaluation 46, 210 199-204,206-208
Pulp industry 243, 247 Roberts, J. 228
Pulp manufacturer 63, 64 Roll, R. 89, 123
Purchasing Power Parity (PPP) 19, 42, Roll-over credit 79
86-92, l22, 205, 209, 241, 255, 263 Rolls Royce 243, 245
Put option 48,159-160,162,185,188 Ronen, J. 237
Rosenfeld, P. 236
Q
Quantity effect 53, 58-61, 71, 73, 80, S
98,107,261 SAAB 134
Sadan, S. 237
R Sales price 35, 57
Range forward 188 Sales revenue 54-55, 58, 135-139,
Rappaport, A. 27,228 141-144,149-152,154
Raw material price 140 Sales volume 13, 58, 101-103, 105,
Real effective exchange rate 91, 142 139, 145,153, 200
Real exchange rate 12, 17, 39, 86, 89, Samuelson, R.A. 236
91-92,94, 101, 109, 114, 122-123 SAS 20
145,148,183,200,2IO,224,235, Scania 244
264,266 Scenario analysis 26, 41, 101,112,117,
Real option 14,23,35,46,192, 119,121,124,153,238,261
196-197, 209,212,216, 224-226, Schmidt, E 236
228-230,266 Schroeder, W. 237
Real wage cost 46 Schwert, W. 122
Regulation FD z54 Seasonal factor 140, 146
Relative labour cost 2-3, 61, 210 SEAT 21-22
Relative PPP 88, 92 Securities and Exchange Commission 254
Relative price coefficient 114 Selective hedging 195,206,266
Relative product price 132 Selective strategy 208
Renault 134 Sercu, P. 236
Renegotiation 158 Shank, J. 234
Required rate of return 33 Shapiro, A. 22,35,98
Revenues 18, 21, 54-55, 57-58, Shareholder Value Analysis (SVA) 13,
104-105,135,137,139,14I-144, 27,228,259
149-152, 154, 158, 196, 219, 229 Shareholders' wealth 38, 195-196
Revolving loan 74, 97 Short-run variability 65
Risk attitudes 194-195, 199, 202, 206, Short-term loans 59, 79, 129
209,212,263 Short-term profit maximization 36
Risk diversification 33 Short-term security 79
Risk factor 37,40,44,116,229 Skoda 22
Risk management programme 28, Solnik, B. 121-123
43-44,49-50,117,194 Sources of instability 130-131
Risk management strategy 41,156,206, Sourcing 225
241,264 Special Drawing Right (SDR) 172
Risk premium 20,33,41,94-95,201 Speculative contract 168, 191, 193
Risk profile 186-187 Speculative opportunity 202
Risk reduction 43, 45, 172 Speed of price adjustment 22
Risk-averse behaviour 35, 38 Spot contract 157
288 index
Spot exchange rate 44, 95 U
Srinivasulu, S. 22, 241 Unanticipated change 28-30,39-40,
Stakeholder 11, 13, 27-28, 33-36, 49, 70-71, 100, 111-112, 115, 129, 133,
67, 152, 154, 193-194, 196, 199, 139, 151, 198, 220, 223, 228
231-232, 255, 257-258, 260, 263, Unexplained variance 183
265, 268 Unit labour cost measure 91
Stambaugh, F. 123 Unsystematic risk 30
Standard No. 8 234 Upside risk 30
Stanko,B.B. 235-236 USdollar 12.,17,30,63,65,97,159,
Staubus,G. 235-236 251
Sterling, R.R. 236
Stewart, B. 228 V
Stickney, C.P. 235-236, 241 Valuation effect 58-59,61,71-73,261
Stockholder 34, 62, 78, 219 Value at risk 38,73,76-77,259-260
Stock-market value 31,62,67-68, Value enhancement 194
120-121,128,198, 212 Value maximization 36
Stonehill, A. 98 Value of asset 164
Strategic management 13 Value-added 91
Strategy choice 81 Value-based Management (VBM) 26,
Sunder, S. 236 214-216, 222,228
Support system 43 Variability of cash flow 46, 44, 152,
SVA 13, 27, 228, 259 197-199
Swap arrangement 158 Variance reduction 197-198, 166, 268
Swaption 188 Vickrey, O.W 23 5
Sweeney, J. 89, 236 Volatility of exchange rate 234,257
Synthetic forward contract 181 Volkswagen 21
Systematic risk 30 Volvo Cars 58, 111, 124-154, 197-198,
218
T Vulnerability of corporate performance
Tactical decision 45, 268 241
Tax advantage 43
Tax consideration 157, 167, 170, 189 W
Tax shield 43, 102-103,106 Wages 46,101,200-201, 225, 253
T-bill 95, 181-182 Wallace, S. 235
Term structure of interest rate 171, Walsh, P. 237
201, 264 Wang, W. 237
Term of trade 89 Watts, R. 237
Theta 180 Weissenreider, 228
Three-month forward exchange rate 44 Westwick, C.A. 236
Time horizon of exposure 41, 128 Wholesale price index 90-91
Tradable security 31 Wihlborg,C. 12,22, 112,122,155,193,
Trade credit 211 200, 228, 230, 235, 241, 261
Trade imbalance 17 Wolfson, A. 235-236
Transaction Cost 44, 88, 95, 188, 208
Transaction exposure 52-58, 60-61, 68, Z
70,104,157,159-161,168 Zeller, T.C. 235-236
Translation rate 66, 68 Zhou, S. 235
Trigger level 184, 225-227, 230 Ziebart, D.A. 235-236
Trigger point 120 Zimmerman, J. 237
Translation method 52, 64-66, 165
Target variable 34, 148, 195-196,199,
201-202, 212, 250, 263
Trade policy 16, 19