OVERVIEW FINANCIAL STRATEGY MBA5924

1.

Module Overview

2. Study Schools 3. Prescribed Books 4. Case Studies 5. Articles 6. Web Links 7. Assessments 8. Topics

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1. MODULE OVERVIEW

In Financial Management we learnt about the basics of accounting and finance. In this module the emphasis is on application of the tools and techniques and in particular we will look at how an organisation manages its financial risk profile and will deal with the following topics: Company valuation Risk assessment o o o o o Interest rate risk Foreign exchange risk Contingent risk Credit, liquidity risk Operational risk

Measuring performance

In this module, it is important to be aware of the financial implications of strategic decisions. Therefore, each topic will be linked to appropriate concepts in the Strategy module. 2. TUTORIALS AND ONLINE RESIDENTIAL SCHOOL

There are currently no tutorials scheduled for this module. Tutors may however make arrangements with their groups to conduct tutorials as and when the need arises. Such arrangements are voluntary on the part of tutors. Students are advised that it is against the university policy to render remuneration of any kind to tutors under such arrangements. We recommend that you seek assistance from third parties that are not directly involved with the tuition of the module.

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It is also strongly suggested that you participate in a self-help group that meets regularly (either online or face-to-face). Self-help groups do not involve tutors, and are formed and managed by students themselves. There will be no online residential school (ORS) for this module. The ORS material has been incorporated into the tutorials in order to give you more time to reflect on the different concepts. 3. PRESCRIBED BOOKS

You will receive most material required for this module as part of your course pack. This includes: Course File Units 6 to 10 Financial Strategy 2nd edition (Rutterford, Upton and Kodwani, 2006) Vital Statistics DVD Audio CDs CDs with course software Additional material provided on EDS.

At the end of each unit reference is made to additional reading in the form of published articles and books. Students are strongly encouraged to read a selection of these articles. Articles are available from the library and students should seek the assistance of the librarians at both the SBL and main campus. The following textbooks (see additional recommendations in MBA5923 under this section) are recommended for further reading: 1. International Financial Management, 5th edition, Cheol S. Eun, Bruce G. Resnick McGraw Hill [ISBN 9780078034657] 2. Financial Markets and Institutions: A modern perspective, 2nd Ed, Anthony Saunders and Marcia Million Cornett, McGraw Hill, 2004, [ISBN: 0072824549] 4. CASE STUDIES Nike Inc

5. ARTICLES Financial Strategy 2nd edition (Rutterford, Upton and Kodwani, 2006) is included in the course pack, and articles are referenced both in the units and in this course outline. For this module, the articles in Parts IV to VI are most applicable. King II Report on Corporate Governance (RSA) Sarbanes-Oxley Act (USA) Cadbury Reports (UK)

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6. WEB LINKS The same internet sites discussed in the Financial Management module (MBA 5923) would also apply to this module. Institute of directors

7. ASSESSMENT

7.1. Individual assignments

All assignments (tutor-marked assignments or TMAs) for this module are individual assignments.

General guidelines: TMAs are marked by tutors and moderated by the Course Team Leader. No extension for submission of TMAs will be granted unless accompanied by a medical certificate or a letter from your employer. Applications for extensions should be directed to the course administrator at the SBL and NOT to tutors.

YOU WILL GENERALLY BE ASSESSED ON:

Your ability to analyse questions from a financial viewpoint Your ability to introduce, develop and conclude a logical argument to answer the question Your ability to select and apply appropriate Financial Strategy MBA 5924 course concepts to the material in support of your argument TMAs are limited to a maximum word count of 1,500 words. This is in your own interest as students that write too much in the hope that their answer is contained somewhere in the TMA, often contradict themselves, to their detriment.

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7.1.1 TMA 1 (25 % OF THE YEAR MARK FOR THIS MODULE)

Due date: 27/02/2012

This assignment, in addition to its contribution to 25% of the year mark also serves as the university assignment that qualifies you for entry into the year- end examination (Assignment 3). Failure to undertake this assignment will result in your deregistration from the module. Question 1 [30]

Each of the following fifteen (15) questions has only ONE correct answer. Write down the number and the letter which, in your opinion, represents the correct answer. 1.1 A. The major components of the Sarbanes-Oxley Act include all of the following except Accounting regulationThe creation of a public accounting oversight board charged with overseeing the auditing of public companies and restricting the consulting services that auditors can provide to clients. Audit committeethe company should appoint independent "financial experts" to its audit committee. Shareholder voting rights reform"one share one vote" is now the law of the land. Executive responsibilityCEOs and CFOs must sign off on the company's financial statements. None of the above is correct Calculate the forward per annum premium or discount given the following information:

B. C. D. E. 1.2

Spot 1 = $14000; 3 month forward 1 = $14200 A. B. C. D. E. 1.3 1. 2. The $ is at a premium of 143 percent The $ is at a discount of 143 percent The $ is at a premium of 571 percent The $ is at a discount of 571 percent None of the above Consider the following statements concerning financial derivatives. Interest rate swaps are a form of over-the-counter derivative. A European-style option will give the right to buy or sell at any time up to and including the expiry date.

Which ONE of the following combinations (true/false) is correct? A. B. C. D. E. Statement 1 True True False False None of the above Statement 2 True False True False

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1.4

Sinai Limited is financed entirely by equity and earnings per share are expected to be R030 for the forthcoming year. The company earns a constant return of 12% on its investments and pays a constant dividend payout ratio of 25%.

What is the predicted market value per share? A. B. C. D. E. F. 1.5 R036 R063 R083 R250 R030 None of the above Volume Ltd is seeking to borrow 50 million for five years at a variable rate of interest and Appples Ltd is seeking to borrow 50 million for five years at a fixed rate of interest. The amount required by each company can be borrowed at the following interest rates: Variable rate LIBOR + 12% LIBOR + 14% Fixed rate 52% 60%

Volume Ltd Appples Ltd

The two companies enter into a swap arrangement and any benefits are shared equally. What is the net annual interest rate for Volume Ltd when LIBOR is 5%? A. B. C. D. E. 1.6 57% 58% 59% 61%. None of the above Sahara Limited wishes to take out a $20 million loan in three months time and to fix the interest rate for a nine-month period. A forward rate agreement will be used to hedge interest rate risk and the following rates have been quoted by a bank: Bid % 352 363 Offer % 345 355

3 months v 9 months 3 months v 12 months

Sahara Limited can borrow at 50 basis points above LIBOR and, at the fixing date, LIBOR is 325%. What is the rate of interest that Sahara Limited will pay to the bank as a result of the forward rate agreement? A. B. C. D. E. F. 020% 027% 030% 038% 040% None of the above

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1.7 1. 2. The following financial options are held by an investor at their expiry date: A call option on 40,000 shares in Nabian Limited with an exercise price of $625. The market price of a share at the option expiry date is $692. A put option on 800,000 in exchange for US dollars at a strike rate of 1 = $160. The exchange rate at the option expiry date is 1 = $165.

Which ONE of the following combinations (exercise/lapse) concerning the above financial options should be applied? A. B. C. D. E. 1.8 Call option Exercise Exercise Lapse Lapse None of the above Put option Exercise Lapse Exercise Lapse

The shares of Taber Limited have a beta of 04 and investors have an expected rate of return of 6%. The shares of Oles Limited have a beta of 15. The expected returns to the market are 12%.

Using the Capital Asset Pricing Model, what is the expected rate of return for investors in Oles Limited? A. B. C. D. E. F. 1.9 15% 17% 20% 24% 12%. None of the above According to a colleague, the Combined Code states that the remuneration committee should have delegated responsibility for setting the remuneration of: Non-executive directors. The chairman.

1. 2.

Which one of the following combinations (true/false) is correct? Statement 1 True True False False None of the above What is the correct definition of value at risk? A single number estimate of how much a company can lose due to the price volatility of the instrument held The standard deviation of the changes in value of the total portfolio of instruments held by a company The variability of movements in a securities price The total amount of interest payable as a percentage of the amount lent or borrowed. None of the above Statement 2 True False True False

A. B. C. D. E. 1.10 A. B. C. D. E.

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1.11 Call options on XYZ Corporations common shares trade in the market. Which of the following statements is most correct, holding other things constant? The price of these call options is likely to rise if XYZs share price rises. The higher the strike price on XYZs options, the higher the options price will be. Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months. If XYZs stock price stabilizes (becomes less volatile), then the price of its options will increase. None of the above is correct Which one of the following is an example of a flexibility option? A company has an option to invest in a project today or to wait a year A company has an option to close down an operation if it turns out to be unprofitable. A company agrees to pay more to build a plant in order to be able to change the plants inputs and/or outputs at a later date if conditions change. A company invests in a project today to gain knowledge that may enable it to expand into different markets at a later date. None of the above is correct Which of the following statements about interest rate and reinvestment rate risk is correct? Variable (or floating) rate securities have more interest rate (price) risk than fixed rate securities. Interest rate price risk exists because fixed-rate debt securities lose value when interest rates rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested. Interest rate price risk can be eliminated by holding zero coupon bonds. Reinvestment rate risk can be eliminated by holding variable (or floating) rate bonds. None of the above is correct Suppose that the current exchange rate is 1.00 = $1.60. The indirect quote, from the U.S. perspective is: 1.00 = $1.60 0.6250 = $1.00 1.60 = $1.00 0.6250 = $1.60 None of the above is correct
It is conventional to classify foreign currency exposures into the following types: Economic exposure, transaction exposure, and translation exposure Economic exposure, noneconomic exposure, and political exposure National exposure, international exposure, and trade exposure Conversion exposure, and exchange exposure None of the above is correct

A. B. C. D. E. 1.12 A. B. C. D. E. 1.13 A. B.

C. D. E. 1.14 A. B. C. D. E.
1.15 A. B. C. D. E.

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Question 2 THIS QUESTION HAS TWO (2) UNRELATED PARTS PART A [15] [25]

Siyaya Limited owns a large chain of bookshops, which operates throughout the Republic. Over the past three years the company has struggled to maintain its market share in the face of fierce competition from internet retailers and from large supermarket chains. The board of directors of Siyaya Limited has therefore decided that, in order to reduce risk and to secure future growth, the company must diversify its operations. To this end, the board is now negotiating with the board of directors of Phaphama Limited, a food manufacturer, with a view to acquiring the company. The two boards of directors have agreed a share price but have yet to agree the form of bid consideration. The board of Siyaya Limited would prefer a share-for-share exchange whereas the board of Phaphama Limited would prefer a cash offer for the shares of the company. REQUIRED: (a) In bullet point form, briefly discuss whether diversification through mergers and acquisitions is an effective means of reducing risk and securing future growth and use the information in the question to illustrate your answer. In bullet point form, outline the advantages and disadvantages of a sharefor-share exchange and a cash payment as forms of bid consideration. [7]

(b)

[8]

PART B

[10]

Photo Limited is considering a bid for Dancer Limited. Both companies are stock-market listed and are in the same business sector. Financial information on Dancer Limited, which is shortly to pay its annual dividend, is as follows: Number of ordinary shares Ordinary share price (ex div basis) Earnings per share Proposed payout ratio Dividend per share one year ago Dividend per share two years ago Equity beta Other relevant financial information: Average sector price/earnings ratio Risk-free rate of return Return on the market 5 million R330 400c 60% 233c 220c 14 10 46% 106%

REQUIRED: (a) (i) (ii) (b) Calculate the value of Dancer Limited using the following methods: Price/earnings ratio Dividend growth model Discuss the significance, to Photo Limited, of the values you have calculated, in comparison to the current market value of Dancer Limited

[3] [4] [3]

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Question 3 PART A [25] [15]

An insurance company is analyzing three bonds and is using duration as the measure of interest rate risk. The three bonds all trade at a YTM of 10 percent and have R10 000 par values. The bonds differ only in the amount of annual coupon interest that they pay: 8, 10, or 12 percent. (a) (b) (c) What is the duration for each five-year bond? State the relationship between duration and the amount of coupon interest that is paid? Use a graph to show the relationship between duration and the amount of coupon interest that is paid (Note: Use ordinary plain paper to draw an approximation of the graph). (9) (3) (3)

PART B

[10]

In an interest-rate swap transaction, Large corporation Limited can borrow in the bond market at a current fixed rate of 9 percent and can also obtain a floating-rate loan in the short-term market at the prime bank rate. However, this firm wishes to borrow short-term because it has a large block of assets that roll over into cash each month. The other party to the swap is Small corporation Limited, with a lower credit rating that can borrow in the bond market at an interest rate of 11.5 percent and in the short-term market at prime plus 1.50 percent. Small corporation Limited has long-term predictable cash inflows, however. Large corporation Limited wishes to pay for its part in the swap an interest rate of prime less 50 basis points. Small corporation Limited is willing to pay the underwriting cost associated with the Large corporation Limited 's security issue, which is estimated to be 25 basis points. The swap transaction is valued at US$100 million. REQUIRED (a) (b) (c) With the aid of a diagram, show how the swap can be executed If the prime bank rate is currently 10 percent, who will pay what interest cost to whom? Explain what the benefit is to each party in this swap will be. Maximum (4) (3) (4) 10

10

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Question 4 [20]

Giza Limited is an Egypt supermarket chain with subsidiaries in a number of different countries of the Middle East. Some years ago, the company entered the US market but the financial results proved to be disappointing. As a result, the company recently agreed to sell its US stores to a rival US supermarket chain for USD250 million. An initial payment of USD100 million has already been received and the balance is due to be received in three months time. The directors of Giza Limited have to decide whether, and if so how, to hedge against the foreign exchange risk arising from this balancing payment. They are considering three possible options: 1. To take out a forward exchange contract. Exchange rates are: EGP1 = USD15806 USD15852 USD00082 USD00072 premium

EGP/USD spot 3-months forward 2. 3.

To take out a currency option. A bank has offered an over-the-counter option at an exercise price of EGP1 = USD160 and at a premium cost of EGP110 per USD100. To do nothing.

During their deliberations, the directors dismissed the idea of currency futures contracts as they were not clear as to how they could be employed for this particular hedging transaction. REQUIRED: (a) Show the effect of each of the three options being considered, assuming that the exchange rate has moved in three months time to: (i) EGP1 = USD165; (ii) EGP1 = USD150 (iii) Do nothing Discuss the results in (a) above. Describe the nature of currency futures contracts and explain how a currency futures contract should be arranged in order to hedge the currency exchange risk faced by Giza Limited.

(b) (c)

(3) (6) (3) (4) (4)

7.1.2

TMA 2 (75 % OF THE YEAR MARK FOR THIS MODULE)

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Due date: 12/03/2012 CASE STUDY [100]

Obtain the case Nike Inc from the EDS. Analyse the case in the form of a report to the board. The report should be in the following format 1. 2. 3. 4. 5. 6. 7. Executive Summary Back Ground Qualitative Analysis Quantitative Analysis Conclusion Recommendations Appendices

The following are the guidance question that will assist you to analyse the case. Please note that these are only a bare minimum 1. What is the WACC and why is it important to estimate a firms cost of capital? Is the WACC set by investors or by managers? Do you agree with Joanna Cohens WACC calculation? Why or why not? If you do not agree with Cohens analysis, calculate your own WACC for Nike and be prepared to justify your assumptions. Calculate the costs of equity using CAPM, the dividend discount model, and the earnings capitalization ratio. Which method is best for calculating the cost of equity? What are the advantages and disadvantages of each method? What should Kimi Ford recommend regarding an investment in Nike?

2. 3.

4.

The following resources are made available to the student: 1. 2. 3.

The PDF file containing the case study Nike, Inc A PDF file entitled Report Writing - The essentials The OUFS excel spreadsheet on CD (This is part of the resources issued to you by the SBL as a boxed package). It is the students call to decide its usefulness in this case.

Guidance on the use of models (excel based) and frameworks for industry analysis.

1. 2.

3.

4.

At this NQF level (8) you are expected to demonstrate skills in analysing and interpreting vast amount of information in order to come up with an informed decision for stakeholders. You are therefore expected to use supporting spreadsheet models in such a way that they aid in the decision making process. Customisation of the models is therefore paramount. Present as part of your answer only the relevant outputs of your model. It is expected that students will have the skill to format excel spreadsheet for printing. Spreadsheets that print rows/columns across a number of pages in a clumsy fashion portray an ill prepared student and such work will be heavily penalised. The use of models like PORTER, PEST though appropriate, should be handled with extreme caution. Only variables relevant to the case on hand can be used. In some instances, cases may not require the use of a particular model at all and students should not force models onto cases. Financial strategy is a numbers course and as such greater emphasis is place on figures. Business strategy is a supporting element that aids in interpreting the computations.

The mark allocation (subject to review without prior notice) is as follows: 1. 2. Executive Summary Back Ground [10] [10]

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3. 4. 5. 6. 7. Qualitative Analysis Quantitative Analysis (Draw ball park figures from part 6 below) Conclusion & Recommendations Appendices (Excel outputs will appear here) Report format & flow of disposition Total [15] [20] [10] [30] [5] 100

Total marks will reflect the following outcomes Unacceptable (<25 marks) Fail (25-40 marks) Failure to use course models or to present a critical analysis. Insufficient calculations of key variables and incoherent report format and argument flow. Some use of course concepts, but minimal and weakly developed. At least one but not all of the main areas in Units 5 to 10 will be properly analysed. Suggestions for changes will be imprecise and will lack clear links with the preceding analysis. Insufficient calculations of key variables and incoherent report format and argument flow.

Competent (4175 marks)

Good (>75 marks)

Appropriate analytical models will be used in the key areas, and proposals for change will be credible and supported by analysis. We would expect answers in this category to be well structured. Some semblance of a report structure and attempt at argument flow. Effective and appropriate use of concepts and models to provide powerful analysis and to make perceptive recommendations for changes. The answer will be well structured and presented, as well as fully and correctly referenced. Adequate figures to support analysis and recommendations and good argument flow.

7.2 Examination structure The examination for MBA 5924 will be an intensive TMA. Students are expected to demonstrate the ability to use ideas from the full range of topics in this module, and the focus is on application rather than on pure theory. More detailed examination guidelines will be made available before the examination. An example of exam requirements is provided below. An exam case study will be made available to students prior to the exam. For this paper, you will be assessed on your ability to select and apply appropriate course concepts from the whole range of MBA 5924 topics and concepts your ability to show your understanding of theoretical principles by its application your ability to interpret results from analysis in line with the question the quality of your argument and conclusions The examination paper may consist of multiple choice questions, essay-type question and/or a case study, or any combination of the three.

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8. TOPICS 8.1 Company Evaluation 8.1.1 Tuition period

Consult course calendar

8.1.2

Specific outcomes

By the end of this unit you should be: familiar with the three main methods of company valuation book value, market multiples and discounted cash flow; able to appreciate the merits and disadvantages of each technique; able to decide on the most appropriate method or methods of valuation according to the circumstances regulation, New issue, privatisation, takeover or restructuring. 8.1.3 Critical questions

Unit 6 takes the same theories used in project appraisal but applies them to valuing an entire organisation. This unit also uses the forecasting skills developed in Unit 2 and 3, and so draws together both accounting and finance areas. View the second programme on the DVD on company valuation. This programme illustrates how different valuation techniques can yield surprisingly different values for the same company. The audio programme 3 is also highly recommended. Take a moment to reflect on the following question: What is the most appropriate method for evaluating a company?

We shall investigate the following topics: Valuing the assets Market multiples Discounted cash flow Valuation in context

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8.1.4 Learning through activities The most important sources of information for this topic are Units 2, 3 and 6. You would also need to consult chapters 4,5,8,9 and case study 8 in Financial Strategy 2nd edition (Rutterford, Upton and Kodwani, 2006).

Link to Strategy: The value of a company depends on both its tangible as well as its intangible assets. How these resources are combined give rise to capabilities that convey a strategic competitive advantage. Consult the textbook (Grant, 2008) as well as Unit 3 of the Strategy Modules and part III of the Strategy Reader (Segal-Horn, 2004)

8.1.5

Self-assessment

Using the different techniques discussed in this section, calculate the value of the organisation where you are employed. Compare your values to the market value. If you work for a not-forprofit organisation, use published information of a firm that is listed on the JSE.

8.1.6

Reflection

Now that you have assessed yourself on this topic, the following question may help you to reflect on your learning so far: What elements in your organisation you believe should change to improve its value?

8.1.7

Conclusion

This concludes the sections on valuation. We will now focus on risk, especially financial risk. 8.2 Risk assessment and interest rate risk

8.2.1

Tuition period

Consult course calendar

8.2.2

Specific outcomes

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Understand the general implications of risk for an organisation Categorize the forms of risk to which an organisation is subject Plan and carry out a risk assessment exercise Understand the concept of interest rate risk Calculate the duration and understand it use for quantifying interest rate risk Produce a gap chart Understand the concepts Value at Risk Forward Rate Agreement (FRA) Futures Swaps

8.2.3

Critical questions

Risk can be defined (in Financial Strategy terms) as being an uncertain outcome that would improve or worsen our position. There are two elements of this definition It is probabilistic The likely outcome can be assessed but is not known for certain It is symmetrical The outcome may be pleasant or unpleasant

Think about the following question: What risks can you think of that affect you as a manager? How would you go about managing such risks?

In this section we deal with the following topics: Risk assessment Interest-rate risk Duration Measuring and managing aggregate interest rate exposure Interest-rate risk management instruments: FRAs and futures swaps

8.2.4

Learning through activities

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Unit 7 is a source of information and guidance on this topic. Chapters 11, 12 and 13 of Financial Strategy 2nd edition (Rutterford, Upton and Kodwani, 2006) can also be helpful. You should also listen to audio programme 4.

Link to Strategy: To a large degree, the designing of financial systems depends on the culture of an organisation. This means how authority levels (organisational structure and power distribution) and how the control systems are aligned. These aspects are covered in Unit 6 of the Strategy Modules.

8.2.5

Self-assessment

If the organisation where you are employed has a risk matrix, what are the areas that have the most risk and what steps are done to mitigate such risks? How are the risks in the risk register prioritised for action?

8.2.6

Reflection

Interest rates are in the media spotlight in South Africa as the Reserve Bank has raised rates by over four percentage points in eighteen months. What would be a prudent course of action for an organisation that is subject to the fluctuations in interest rates?

8.2.7

Conclusion

We have introduced the concept of risk and applied it to interest rates. In the next section we look at foreign exchange risk and contingent risk. 8.3 . Foreign exchange and Contingent Risk

8.3.1

Tuition period

Consult course calendar

8.3.2

Specific outcomes

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Explain the difference between transaction, translation and economic exposure Understand spot and forward exchange rate Describe the linkage between forward exchange rate variability Describe some of the determinants of exchange-rate variability Design a hedging strategy to control foreign exchange risk Understand contingent risk

8.3.3

Critical questions

What is meant generically by forex risk? It is the risk that there will be a change in value for the organisation caused by the variation in relevant exchange rates: Sometimes the change is reflected in actual cash flow difference Sometimes it is reflected in a change in recorded value but no funds move

Think about the following: If the organisation where you are employed imports or exports products, how does it protect against unfavourable movements in foreign exchange rates? Would the organisation still be affected by such movements if it does not import or export anything?

In this section we explore the following topics: What is foreign exchange risk? The market for foreign exchange The mechanics of foreign exchange Forecasting foreign exchange rates Techniques for exposure management Options

8.3.4

Learning through activities

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Foreign exchange plays a significant role in the South African economy. With the very capital intensive programme to ensure continuity of electricity supply and the infrastructures for the Soccer World Cup, the country is spending hundreds of billions of Rand, most of it on imported equipment. What effect do you think such spending will be the exchange rate?

Links to Strategy: The link is international strategy, covered in Unit 7 of the Strategy Modules. Even a local company that manufactures and sells its products locally is affected by exchange rates as companies abroad could export their goods into South Africa, thus potentially forcing local prices to be competitive with international ones. Remember the section National or International sources of Competitive Advantage, on page 24 of Unit 7 of the Strategy Modules. Currently the Department of Trade and Industry is investigating such practices called: Import Parity Pricing, and the aim to analyse whether such practices hamper downstream (higher valueadded) production. What is your view? You should also consult Chapters 18, 19 and Part IV of the Strategy Reader 9Segal-Horn, 2004).

8.3.5

Self-assessment

To what extent is the organisation where you are employed exposed to foreign exchange risk. What contingent risks do you believe exist?

8.3.6

Reflection

How do you lenders and borrowers handle the risk inherent in fluctuating exchange rates? How would you go about mitigating the risks caused by a volatile South African exchange rate? What in your view is better a strong or a weak currency (motivate your answer)?

8.3.7

Conclusion

In the first two sections on risk, we looked quite broadly and external to the organisation. In the final section on risk we examine the effect on the organisation directly.

8.4 Credit, Liquidity and Operational Risk

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4.8.4.1 Tuition period

Consult course calendar

4.8.4.2

Specific outcomes

Credit risk How the exact extent of credit exposure should be measured The techniques used by organisations to make decisions about credit exposure (Moodys) Methods companies can use to contain credit exposure Facilities to manage credit risk The use of credit-derivatives

Liquidity risk Circumstances under which liquidity problems arise Structuring the balance sheet to maintain an acceptable liquidity position

Operational risk Operational risk is a wide ranging category embracing the financial risks arising from the failure of systems, controls or people.

4.8.4.3

Critical questions

The easiest systems to change are those which are internal to the organisation. Which systems in the organisation need to be modified to mitigate the overall risk profile of the organisation?

Take some time to reflect on the following questions: What risks does the organisation face with regards to bad/poor debt? Consider what your strategy would be when dealing with countries with high risk such as Zimbabwe. What liquidity challenges does the organisation face? How does it address them? What operational risks have been uncovered? What risks are there likely to emerge in five years time? Consider the skills shortage in South Africa with the average age of a civil engineer reported to be 53.

Here we explore the following topics:

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Credit risk Credit lines Credit-risk management Liquidity risk Operational risk Financial risk management from theory to practice

4.8.4.4

Learning through activities

Unit 8, chapters 10 and 14 in the Financial Strategy Reader cover this section adequately.

Links to Strategy: This section links to the following sections in the Strategy module: Corporate culture (Unit 6) Control systems (Unit 6) Resources and capabilities (Unit 3) Change management (Unit 6) Chapter 13 of the Strategy Reader (Segal-Horn, 2004)

8.4.5

Self-assessment

Describe a significant operational risk that has been uncovered within the past year. How did the organisation address this risk?

8.4.6

Reflection

Does uncovering a risk always involve change? What options are available if the risk cannot be managed but needs to be endured as it involves a core process of the firm?

8.4.7

Conclusion

This topic ends off the sections dealing with risk. The next topic examines performance in organisations.

8.5 . Measuring performance

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8.5.1 Tuition period Consult course calendar

8.5.2

Specific outcomes

Assess the relevance and relative efficiency of different structures of corporate governance; Describe how external investment managers and internal line managers assess the performance of different investments and operating units respectively; Show how performance measures such as economic value added, CFROI and DCF analysis can be used both as external and as internal measures. Apply the principles of value-for-money auditing in the context of the public sector; Describe the financial objectives and performance measures used by institutional investors such as pension funds.

8.5.3

Critical questions

The basic principles of financial control that are employed throughout the savings and investment process, from individuals assessing the performance of their investment in shares of a company against their long-term investment objectives, to the departmental managers judging their units performance against its operating budget; the main systems employed by providers of finance and by the markets in order to align the users behaviour with the providers investment objectives; the analogous procedures adopted by controllers and trustees of public sector and not-for-profit organisations to ensure that their managers achieve their financial objectives, in particular, by maximizing value for money, have one thing in common, performance!

Some of these questions are: How well is the investment performing? What options are available if the investment is performing below par? The elements addressed in this topic are: Corporate governance Measuring corporate performance Performance and governance in not-for-profit sectors

8.5.4

Learning through activities

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Units 1 and 10 address this topic. Along with that, Parts 5 and 6 of Financial Strategy 2nd edition (Rutterford, Upton, Kodwani) contains some very insightful articles. Audio programme 5 is also extremely useful. Read Chapter 9 of the textbook. Read the King II report on corporate governance.

Links to Strategy: Corporate governance and performance link back to how well the organisation is being run. It touches, again on the control mechanisms (Corporate Governance) as well as on leadership. We would suggest that you read Unit 4, section 4 as well as Unit 6, Section 3 of the Strategy Modules. You might also want to consult Section 2.8 of Unit 7 (Issues of Risk, Governance and International Ethics)

8.5.5 Self-assessment

Compared to its peers, how well is the organisation performing?

8.5.6 Reflection

We have reached the end of this module on financial strategy. Lets consider the following questions: How will your behaviour in your organisation change as a result of your learning in this module? What elements of this module could your management and colleagues benefit from?

8.5.7 Conclusion

We have reached the end of this module on Financial Strategy.

We would also like to take this opportunity to with you the best for the exams in this module and good luck with the rest of your studies.
UNISA 2012

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