360 Planning and Forecasting
require, for example, the use of either exchange-traded or over-the-counter de-
rivative instruments.
While somewhat less contemporary, there are other examples of using a
firm’s own operations and activities to offset foreign-currency exposure. For
example, California First Bank (now part of Union Bank) had a Swiss franc
borrowing in the amount of Sfr20 million.^9 As this represented liability expo-
sureto California First, Exhibit 12.1 shows that an increase in the value of the
Swiss franc results in a foreign-currency transaction loss. The goal of the hedge
would be to create a gain in this circumstance to offset the loss on the Swiss
franc borrowing. Again, Exhibit 12.1 reveals that a gain would be produced
from asset exposure in the Swiss franc in the case where the Swiss franc ap-
preciated in value.
California First Bank sought an opportunity to establish an asset position
in the Swiss franc for the same amount and term as the existing Swiss franc
obligation. It created this offsetting position by making a loan and denominat-
ing the loan in the Swiss franc. This apparently met the borrower ’s needs and
also served the hedging objective of California First Bank.
In an even more creative arrangement, Federal Express created a natural
hedge of a term loan that was denominated in the Japanese yen.^10 This was ac-
complished by a special structuring of transactions with its own customers. As
Federal Express explained:
To minimize foreign exchange risk on the term loan, the Company has commit-
ments from certain Japanese customers to purchase a minimum level of freight
services through 1993.Federal Express needed Japanese yen to make periodic repayments on
the term loan. The arrangements with its Japanese customers ensured that yen
would be available to pay down the term loan. If the yen appreciates against
the dollar, the dollar burden of the Federal Express yen debt increases and re-
sults in a transaction loss. However, this loss is offset in turn by the increase in
the dollar value of the stream of yen receipts from the freight-service con-
tracts.^11 If instead the yen depreciates, a gain on the debt will be offset by
losses on the service contracts. A summary of the operation of this hedge is
provided in Exhibit 12.3.
California First and Federal Express both employed arrangements with
their customers in order to create hedges. In addition, purely natural hedges
EXHIBIT 12.3 Offsetting gains and losses produced by Federal Express
hedge.
Change in the value of Change in Dollar Value Change in Dollar Value
Foreign Currency of the Loan (Liability) of the Revenue (Asset)
Appreciates Increases (loss) Increases (gain)
Depreciates Decreases (gain) Decreases (loss)