Question

• IBM annual report for the fiscal year ended as on 2018 gives disclosures related to its management of foreign exchange risk under Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations on page no. 66 under the head Currency rate fluctuations and on page no. 67 Foreign Currency Exchange Rate Risk.
• Types of hedging instruments the company uses are forward contracts, futures contracts, interest rate swaps, cross currency swaps and options depending on underlying exposure.
  The company issues debt in the global capital markets to fund its operations and financing business. To manage these mismatches and to reduce overall interest cost, the company may use interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt and to convert specific variable rate debt issuances into fixed-rate debt.
• The Company hedges net investments in foreign operations. A large portion of the company’s foreign currency denominated debt portfolio is designated as a hedge of net investment in foreign subsidiaries to reduce the volatility in stockholders’ equity caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. The company also uses cross-currency swaps and foreign exchange forward contracts for this risk management purpose.

Pepsico is in the retail beverage industry. It has operations in over 200 countries and territories and employees 267,000 people (Pepsico, 2019). Just under half of those employees are in the United States.

Management of foreign exchange risks

            Pepsico discusses how they manage their foreign exchange risk in the Risk Management Framework section of their 10-K. 43% of their net revenues from last year came from operations outside of the United States (Pepsico, 2019). 2018 had an unfavorable foreign exchange, which reduces Pepsico’s net revenue by 1%. The unfavorable exchange came from the devaluing of Russian rubles, Turkish liras, and Brazilian reals against the US dollar.

            Pepsico manages their risk for fluctuation of exchanges rates through strategies that include global purchasing programs, productivity incentives and hedging. Any cash flows from risk reduction activities are included on their cash flow statement as operating activities.

Hedging types and instruments

            Pepsico’s strategies for hedging include using derivatives and debt instruments (Pepsico, 2019). The most common derivative they use are forward contracts with terms of no more than two years. The debt instruments utilized to maintain favorable interest rates are rate swaps, cross currency interest swaps, and treasury locks.

Effectiveness of foreign exchange hedges

            Pepsico has become more successful over the last several years effectively utilizing hedges. This can be seen when analyzing the foreign exchange loss. The better they become at predicting changes, the better hedge positions that can get on the market. In the end this will lead to smaller losses on foreign transactions and higher net revenue.

Required:

Discuss the differences noted in how IBM handles foreign exchange risk. Speculate as to why there are differences based on what has been researched about IBM and what was posted about Pepsico .

Answer 1

the key differences noted are as below:-

Strategies used

IBM-Major portion of IBM strategy is hedging of net investment in foreign subsidiaries to reduce the volatility in stockholders’ equity caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar.

Pepsico- Widely used derivative are forward contracts with terms of no more than two years.

Debt instruments used

IBM-It issues debt in the global capital markets to fund its operations and financing business. To manage these mismatches and to reduce overall interest cost, the company may use interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt and to convert specific variable rate debt issuances into fixed-rate debt.

Pepsico- It manages their risk for fluctuation of exchanges rates through strategies that include global purchasing programs, productivity incentives and hedging.