Question

Do you think it is a good idea for Porsche to hedge 100% of its economic exposure? Why or why not?

Answer 1

Solution

Economic exposure is the exposure of a company to foreign currencies and its sudden or unexpected changes in foreign currency rates. Foreign currency hedging has costs associated with it and the strategies are complicated. A one time 100% hedge of exposure would involve significant costs which may be more than the benefits of hedging; also, the exposure would not stay constant and would fluctuate at the individual currency level thereby leading to mismatches between strategy and exposure.

Porsche needs to draw the line between blanket foreign currency hedging strategy and what exposures it really needs to hedge to have an effective strategy. It would have to be assessing what proportion of its foreign currency asset exposure is subject to declining or depreciating foreign currencies and what proportion of it is not. Similarly, it needs to assess what proportion of its foreign currency liability exposure is subject to strengthening or appreciating foreign currencies and what proportion is not and only if these are significant and the costs of hedging are lower than its benefits, undertake hedging strategies. This would be a continuous decision making process and would not be a one time 100% hedge of its foreign currency exposure.

After assessing the currencies that it is exposed to that depreciate or appreciate depending on whether the exposure is an asset or liability, it needs to understand the significance of that exposure. This is not easy given the fact that there may a large number of currencies that it is exposed to. From the consolidated financial statements in the Annual Report 2019 (pg 127) of the Porsche SE Group, we see that its foreign companies are exposed to 19 currencies. Of these if for e.g. it holds significant net current assets in Argentina, Brazil, India and the Republic of Korea, it might be exposed to significant risk due to the decline in these currencies, similarly if it holds significant net current liabilities in Australia, Canada, China, Czech Republic, Japan, Mexico, Russia etc it might be exposed to significant risk due to the appreciation in the currencies of these countries. All along, Porsche has to continually monitor these currencies and determine at each point in time whether it has to hedge or not. It would have a forex monitoring and hedging cell within its Finance function to take care of this requirement at the central level since decisions have to be continually made on timely basis.

By significance of exposure, we need to understand the proportions of exposure in domestic currency or functional currency of Porsche (i.e. Euros) Then the costs associated with each of the significant currency exposures need to be worked out. These would differ from currency to currency based on the currency forward market makers i.e. the banks. Contracts have to be entered into for each of these currencies. Banks as market makers have charges for these services which need to be factored in and it should be understood whether the losses from the exposures exceed the costs including bank charges to make the hedging strategies meaningful. The company also assesses whether a big change in the significant exchange rates say 10% has a material impact on the pre tax results

Pg 182 of the Porsche SE Group Annual Report of 2019 states 'At the level of the PTV Group, the Porsche SE Group is exposed to operational risks due to exchange rate fluctuations. Contracts of the PTV group are partly concluded in foreign currency. Exchange rate fluctuations from these contractual relationships have an effect on earnings and liquidity unless they are opposing transactions in the same foreign currency. This currency risk is monitored centrally by PTV AG and mitigated by hedges where appropriate. No hedges had been concluded as of the reporting date.

The foreign currency items at the PTV Group as of the reporting date are immaterial for the Porsche SE Group. A 10% change in the significant exchange rates would result in each case in effects on the pre-tax result of under 1  million.'

(Note: PTV Group is a subsidiary of Porsche SE Group)