Foreign Exchange Risk Management at AB Foods

This report discusses the foreign exchange risk management policy at AB Foods, a multinational company in the food sector. It explores the two most important foreign exchange exposures - transaction exposure and economic exposure. The report also provides recommendations on hedging strategies for effective management of the company's business.

FOREIGN EXCHANGE
RISK MANAGEMENT AT
AB FOODS

Table of Contents
Background of AB foods.................................................................................................................3
Foreign exchange risk management policy at AB foods.................................................................3
3.......................................................................................................................................................5
Two Most Important foreign exchange exposure to AB foods...................................................5
Hedging options to be used by AB foods in short term and long term for effective management
of their business...........................................................................................................................5
Hedging techniques for managing transaction exposure.............................................................5
Recommendation on the foreign exchange hedging strategies....................................................6
4.......................................................................................................................................................7
Conclusion of company’s current foreign exchange exposure....................................................7
Challenges....................................................................................................................................7
Best way to forward.....................................................................................................................7
REFERENCES................................................................................................................................8
Books and Journals......................................................................................................................8
Online..........................................................................................................................................8

Background of AB foods
AB foods or Associated British foods is a multinational company in the processing and retailing
of foods sector based in London, UK. It is a second largest producer of many food ingredients in
the world. The present report is based on discussion pertaining to foreign exchange risk
management in the context of AB foods.
The company is having quite good financials in terms of their profit margins but they have
reportedly increased their cash reserved from some percentage which is a major concern for the
company while managing foreign exchange rate volatility and accordingly demanded for taking
exposure into the functional currencies and other currencies in which the company’s transactions
take place (Bandaly, Shanker and Şatır, 2018). The company is headquartered in London, United
Kingdom. So, its local currency is sterling pound in which company usually deals with their
associated business stakeholders. Also, the basic functional currency of the company is the one
associated with its local operations that is, Sterling pound. But due to the company being a
multinational concern, it has operations in many distinct region of the world and accordingly
exposed to many currencies in which its transactions take place. Therefore, when there is a
change in the exchange rates, it gives rise to transactional exposure in the business whereas when
assets, liabilities and other financial results are translated of foreign operations into local or
functional currency that is, sterling pound while consolidating the group’s financial performance
and financial position on balance sheet date, there is an emergence of translation exposure.
Manufacturing facilities of AB foods: It markets its ingredients in all over the world by
restricting its manufacturing facilities to some of the geographical regions that is, Europe, India
and America. So, due to having manufacturing at different regions having different local
currencies gives rise to transaction exposure in the country (Giambona and et.al., 2018).
Sourcing of raw materials in AB foods: There are many business units of AB food’s group who
is indulged in selling and purchasing of raw materials in different foreign currencies such as US
dollars and Euro currency (due to its existence in a Eurozone) which accordingly gives rise to
transaction exposures when there is a fluctuations in exchange rate or when the transactions are
translated into their functional currency that is, sterling pound. There is always some
differentiation present in the exchange rates between two currencies (Bergman and Rosén, 2021).
Remaining activities of business except the sourcing of some of the raw materials is carried out
in a functional currency itself.
Foreign exchange risk management policy at AB foods
Foreign exchange risk management refers to the hedging strategies incorporated by businesses
and investors which includes some measures that can be used to protect the value of assets and
liabilities and cash flows due to the unfavorable fluctuations taking place in the exchange rate of
the currencies in the nearer future. Currencies are considered as the most important and major
factor which derives the threat to the group’s financial performance and financial position that is
AB foods in any given period due to the fluctuations occurred in the exchange rates of the
currencies in which the company used to deal with other business units with functional currency
other than the Sterling pound. So, there must be some hedging strategy in place to lower down

the risk of exchange rate fluctuations which results in adverse impact on the company’s financial
position. The hedging strategy so followed by the company is an act of mitigating the risk of
currency fluctuations and accordingly known as policy of foreign exchange risk management.
As discussed above company is having its operations across the world as it is a multinational
concern, so they are dealing in various currencies while sourcing their raw materials. Also, it
manufacturing facilities are at different countries which again given rise to transaction exposure
as the company used to present its consolidated financial statements in its functional or local
currency which is none other than sterling pound (Annual report of the company. 2019).
Therefore AB foods is exposed to both transaction and economic or translation exposure.
Management of the group continuously review their exposures to various currencies and take
reasonable steps towards hedging the risks associated with the adverse fluctuations in the
transactional currencies by using various hedging instruments such as forwards, futures, swaps
and other commodity derivatives.
For mitigating the risk associated with the long term purchase and supply contracts which are
actually denominated in the foreign currency other than the functional currency, the board and
management of the company has resort to foreign exchange forward contracts in order to
hedge all their exposures to transactional currency (Annual report of the company. 2019).
Borrowings and cash balances are held by the company majorly in their functional currency itself
that is sterling pound in which AB foods transact for its local operations.
Cross – currency swaps are used by the financial risk management team of AB foods to align
the various borrowings of the underlying currencies for balancing the net assets of the group. The
group resorts to financing its operations with the help of borrowings they made locally
denominated in the functional currency in which it operate its business activities. Accordingly,
the net assets held by the group gets reduced which is denominated in non – functional currency
(Annual report of the company. 2020). Therefore, the group then able to reduce their exposure to
economic exposure resulting from the fluctuations in exchange rates of foreign currency while
translating transactions, assets and liabilities into sterling pound.
Hedge ratio: The group usually undertake hedging activities on one to one ratio and the
resulting gain or loss on the date of transactions or balance sheet is accounted for in the
comprehensive income statement of the group.
Foreign currency borrowings: The operations are also finances through borrowings made from
external sources which are not denominated in sterling pounds which are designated as net
investment hedges and the gains or losses associated with these borrowings are charged as gains
or losses arises on the translation of net assets belonging to foreign operations. In the balance of
the group, there is nil foreign currency borrowings for the year ended 2019 in terms of net
investment hedges for foreign operations denominated in US dollars which is one of the major
trading currency of AB foods (Annual report of the company. 2020).
From the face of the balance sheet of the company, it has been recognized that the company uses
currency derivatives, cross – currency swaps and commodity derivatives as an instruments

towards mitigating the risk associated with their diversified operations in terms of multiple
currencies used for transacting with foreign companies. Due to the strengthening of sterling
pound against some of the company’s trading currencies results in the translation loss of 16m.
Also, there is a greater volatility noticed in the exchange rate of sterling pound as against the
major trading currencies of the group during the 2019 – 2020 which is caused partly due to the
emergence of COVID – 19 pandemic and uncertainty associated with UK’s exit from EU
(Annual report of the company. 2020).
3.
Two Most Important foreign exchange exposure to AB foods
As AB foods is a Multinational company and dealing with many countries in terms of sourcing
raw materials and manufacturing facilities established in various countries, it has to transact in
many currencies despite of having sterling pound as its functional currency (García and García,
2017). Therefore, the most important foreign exchange exposure for the company found is as
transaction exposure. The exposure to foreign exchange here may arise will results in higher
costs related to manufacturing facilities and raw materials as it is transacted in currency other
than the functional currency which is sterling pound and the major or unfavorable fluctuation in
it causes transactions exposure for AB foods.
Another most important foreign exposure found with AB foods is when the company undertakes
to consolidate its foreign operations with its local operations and then translate it into its
presentation currency. This exposure to foreign exchange is known as economic or translation
exposure where the company has a risk of adverse fluctuations in foreign currencies against its
functional currency that is, sterling pound. Such an exposure to foreign exchange affects
adversely the profit margins of the concern like AB foods there is an absence of suitable
strategies in order to protect cash flows from any unfavorable or sudden fluctuations in currency
(Giambona and et.al., 2018).
Hedging options to be used by AB foods in short term and long term for effective management
of their business
The above identified two most important foreign exchange exposure pertaining to AB foods that
is transaction and translation exposure, where the former indicates short term exposure to foreign
exchange while the latter indicates long term exposure to foreign exchange.
Hedging techniques for managing transaction exposure
In short term, where the transaction exposure prevails and in order to hedge or eliminate this
exposure there are many short term hedging techniques available for the company to mitigate
their exposure to foreign exchange arising from their day to day transactions such as buying or
selling future contracts, forward contracts, currency option hedge and money market hedge
(Arize and et.al., 2018). Before determining or applying any of these techniques towards
managing transaction exposure, it is necessary for MNCs like AB foods to consider and compare
cash flows resulting from each of these techniques of hedging.
Economic exposure being a long term exposure to foreign exchange also known as operating
exposure do have a significant impact on the market value of the company due to its long term

nature and far reaching effects (Hecht and Lampenius, 2017). The hedging options available to
AB foods to mitigate this exposure is by making investment in foreign exchange trading and by
employing any of the following strategies:
Operational strategies: Obtaining financing in diversified currencies, diversification of
production facilities and product marketing and sourcing flexibility.
Mitigating strategies for currency risks: Currency Risk – Sharing Agreements, Currency swaps,
matching currency flows and back to back loans (Tiwary, 2019).
Recommendation on the foreign exchange hedging strategies
This module provides us with the great idea of how companies having their operations in
different nations are exposed to the risk of foreign exchange fluctuations which can impact its
profit margins both in the short term (due to transaction exposure) and long term (due to
economic exposure) (Jeevanandam, 2020). Along with this it has been evaluated that how such
exposure to foreign exchange fluctuations can be mitigated through the application of hedging
strategies and accordingly there are many recommendation that can be made pertaining to
foreign exchange hedging strategies such as:
 It would be recommended that when the transactions involves large amount, then forward
hedge should be used by buying forward contracts which helps in locking exchange rate
at some future date, while for the transaction involving small amounts, standardized
currency future contracts are suggested to be bought or sold (Omar, Mohammad and
Ahmad, 2017).
 Currency options for mitigating transaction exposure should be used when company
wants to avail option of exercising the contract or not depending upon the market
condition, as options need not necessarily be exercised and there is dual benefit for the
company in terms of insulation from unfavorable exchange rate movements and profit
from favorable exchange rate movements.
 It would be recommended to use money market hedge for locking the value of the foreign
currency transaction in AB foods domestic currency (Sterling pound) (Boudt and et.al.,
2019).
 Matching currency cash inflows and outflows can be used to mitigate economic exposure
where companies gets indulged in doing more of their business in one single currency
which includes its borrowings through currency swaps.
 When the price of US $ is expected to go up or down in future this means that there is a
transaction exposure due to foreign exchange fluctuations. When the price rise against
pound then this means more pounds are required to make transactions in USD and this
will raise the cost for company (Opie and Riddiough, 2020). When currency futures are
there in such circumstances, then the company will sell it in locked up exchange rate and
make their purchases without incurring losses of higher costs. The same can be indicated
in the following example:
2% fall Current
exchange rate
2% rise

Exchange
rate
1.3622 1.39 1.4178
Forecasting cash flows
(50% hedging)
GBP = 1682
Hedged amount GBP = 841 USD = 605 USD = 605 USD = 605
Un – hedged exposed
amount
GBP = 841 USD = 617.38 USD = 605 USD = 593.17
TOTAL USD =
1222.38
USD = 1210 USD = 1198.17
Profit / (Loss) after hedging 12.38 (11.83)
In this way one month hedging can be done through currency futures or forwards to lock up
the present exchange rate for future transactions.
4.
Conclusion of company’s current foreign exchange exposure
In the context of AB foods, it has a significant exposure to foreign exchange due to having
diversified operations in many different countries. AB food is exposed to risk of exchange rate
fluctuations against many currencies such as USD, Rupees, euro, etc. It would be recommended
to AB foods to use hedging strategies such as currency futures or forwards, money market hedge,
currency swaps, and foreign exchange borrowings (Sudacevschi, 2017). These hedging
techniques may not produces profits but it provides protection against unfavorable fluctuations in
exchange rates. The most important risk element to be focused by the management is of
structural risks which directly affects the company’s income statement showing movement in
costs and revenues item. This risk in terms of foreign exchange exposure greatly affects
company’s cash flows and leads to financial distress due to the reaction of inflows and outflows
of cash in different manner with the change in currency exchange rate.
Challenges
 Identification of the existence of forex exposure at the initial stage.
 Finding the way to mitigate the risk associated if the prevailing exposure to forex has
been identified.
 Coordinating with the payment schedule by ensuring timely payments to vendors and
managing with currency fluctuations at the same time (Bae, Kwon and Park, 2018).
 Tracking global currency market to avoid adverse effect of currency fluctuations on the
company’s financial performance.
 Accessing the right hedging instruments by locking a desirable rate, to take advantage of
positive market situations in a cost effective manner by availing services at a minimum
cost.
Best way to forward
The best to move forward while dealing with the foreign exchange exposure is to hire a foreign
exchange specialist and then utilizing techniques and tools meant for hedging the risks associated
with such exposure, so that protection against losses due to currency fluctuations can be ensured

(Bhasin and Nisa, 2019). Currently AB foods is using many hedging tools with a 1:1 hedge ratio
such as currency swaps, borrowing in foreign currency and forward contracts.

REFERENCES
Books and Journals
Bandaly, D., Shanker, L. and Şatır, A., 2018. Integrated financial and operational risk
management of foreign exchange risk, input commodity price risk and demand
uncertainty. IFAC-PapersOnLine, 51(11), pp.957-962.
Giambona, E., and et.al., 2018. The theory and practice of corporate risk management: Evidence
from the field. Financial Management, 47(4), pp.783-832.
Bergman, F. and Rosén, M., 2021. Strategies for mitigating foreign exchange risk.
García, P. and García, F. J. P., 2017. Financial Risk Management. Springer International
Publishing.
Giambona, E., and et.al., 2018. The theory and practice of corporate risk management: Evidence
from the field. Financial Management, 47(4), pp.783-832.
Arize, A., and et.al., 2018. MNC transactions foreign exchange exposure: An application.
Hecht, A. and Lampenius, N., 2017. How do firms manage their foreign exchange
exposure?. Available at SSRN 2987901.
Tiwary, A. R., 2019. Study of currency risk and the hedging strategies. Journal of Advanced
Studies in Finance (JASF), 10(19), pp.45-55.
Jeevanandam, C., 2020. Foreign Exchange & Risk Management. Sultan Chand & Sons.
Omar, A. B., Mohammad, K. N. B. T. and Ahmad, N. B., 2017. Exposure to foreign exchange
rate risk: A review of empirical evidences. Journal of Insurance and Financial
Management, 2(5).
Boudt, K., and et.al., 2019. The response of multinationals’ foreign exchange rate exposure to
macroeconomic news. Journal of International Money and Finance, 94, pp.32-47.
Opie, W. and Riddiough, S. J., 2020. Global currency hedging with common risk factors. Journal
of Financial Economics, 136(3), pp.780-805.
Sudacevschi, M., 2017. Foreign currency risk hedging. Challenges of the Knowledge Society,
pp.742-746.
Bae, S. C., Kwon, T. H. and Park, R. S., 2018. Managing exchange rate exposure with hedging
activities: New approach and evidence. International Review of Economics &
Finance, 53, pp.133-150.
Bhasin, K. and Nisa, S., 2019. Economic Exposure Management: A Review. IUP Journal of
Financial Risk Management, 16(1).

Online
Annual report of the company. 2019. [Online] Available through <
https://www.abf.co.uk/file.axd?pointerID=d03ec6ad15eb4ccda8017a15d5bd50d7>
Annual report of the company. 2020. [Online] Available through <
https://www.abf.co.uk/documents/pdfs/2020/ar2020/ar2020.pdf>