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Huntington National BankCurrency Risk Management

Managing Foreign Exchange Exposure

Gabriel GiglielloSVP, Sales Manager

Huntington Bankgabriel.gigliello@huntington.com

800-824-5653May 19, 2011

Agenda

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Market Update

Types of Foreign Exchange Risk

Methods of Evaluating Risk

The Risk Management Process

Case Study: Hedging Strategies

Market Update

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Market Update

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What’s driving Foreign Exchange rates? Central Bank forecasts Inflation readings Commodity Prices Risk On/Risk Off

The Federal Reserve and a weaker USD Quantitative Easing and QE2 FOMC monetary policy and “extended period” language

Debt issues for Europe in a rising rate environment PIGS and austerity measures European Central Bank quandary “inflation or growth”

Market Update

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China Appreciation, inflation and growth US China strategic and economic dialogue No longer the worlds Low Cost Producer Increasing Domestic Demand

Emerging markets and imported inflation Energy prices taking a toll on profits Central Bank actions Regional concerns over PBOC actions

Forecast

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Q2 11 Q3 11 Q4 11 Q1 12 2012 2013 2014 2015

EURUSD 1.45 1.42 1.40 1.40 1.33 1.38 1.35 1.36

USDJPY 83.00 86.00 88.00 89.00 95.00 95.00 92.00 94.00

USDCNY 6.45 6.37 6.29 6.23 6.00 6.02 -- --

GBPUSD 1.63 1.64 1.63 1.64 1.64 1.69 1.70 1.60

AUDUSD 1.04 1.03 1.02 1.00 0.96 0.92 0.94 0.90

NZDUSD 0.78 0.76 0.76 0.76 0.72 0.72 0.72 0.69

USDCHF 0.90 0.93 0.96 0.97 1.00 1.05 1.08 1.11

USDCAD 0.96 0.96 0.98 0.98 1.00 1.06 1.05 1.07

USDSEK 6.08 6.10 6.14 6.17 6.49 6.03 6.09 6.14USDNOK 5.38 5.38 5.29 5.37 5.70 5.39 5.70 6.38

USDDKK 5.14 5.14 5.46 5.52 5.96 -- -- --USDMXN 11.78 11.80 11.80 12.00 11.89 12.00 -- --

USDINR 44.50 45.00 44.50 44.00 44.00 43.80 -- --

USDSGD 1.23 1.22 1.21 1.21 1.20 1.20 -- --

Exchange Rate Volatility

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Types of Foreign Exchange Risk

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Risk Management

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Financial Risk

The chance for a gain or loss due to price changes in the financial markets.

Financial risks are peripheral to the central business in which companies operate.

Differs from Business Risk, or the chance of incurring a gain/loss as a result of operating a business in a certain industry or environment.

In the context of foreign exchange, financial risk management refers to identifying and measuring the currency risk that a business is exposed to and then balancing it against the company’s appetite for that risk and the tools available for managing that risk.

A firm should actively manage its financial risk to its own level of tolerance – a decision to do nothing is a financial risk decision.

Foreign Exchange Risk

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Foreign Exchange Risk: The chance for a gain or loss resulting from changes in exchange rates.

Primarily created by import purchases and export sales

Also created by international (foreign currency denominated) assets and liabilities and by international inter-company transactions such as loans, dividends, royalties, franchise & license fees

Accompanies international acquisitions and divestiture

There are two categories of Foreign Exchange Risk:

Transaction Risk

Translation Risk

Transaction Risk

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The US dollar equivalent of international transactions denominated in a foreign currency will change as the exchange rate changes

Includes forecasted and booked transactions Accounts Payable Accounts Receivable Foreign Currency Denominated Debt/Inter-company debt Capital Equipment Purchases Transactions that may occur in the future, such as being awarded a contract Declared Dividends Foreign Interest Payments

A cash flow risk Gains and losses impact income statement

Translation Risk

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The risk that a company’s net assets or income will change in value as a result of exchange rate changes. Sometimes referred to as accounting exposure.

Balance Sheet Exposures occur when consolidating overseas (non-US dollar) net asset position with those of the parent company.

Balance sheet items consolidated at period end rates Gains and losses impact equity

Income Statement Exposure occurs when consolidating overseas earning (non-US dollar) with the income of the parent company.

Income Statement items consolidated at a period average exchange rate

A non-cash risk

Natural Hedging Strategies

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Businesses may create natural hedges of their currency exposure Location of plants Geographic sourcing of inputs Local currency debt

Key Considerations Effective for long-term foreign currency exposures and cash flows Less flexible than financial hedges

Economies of scale, distribution costs, costs of changing Effective when hedging net investment in foreign operations

Foreign currency debt, or a “short position” created with derivatives

Methods of Evaluating Risk

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VaR – the Value-At-Risk Model

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VaR is one procedure used for estimating the probability of portfolio losses exceeding some specified proportion based on a statistical analysis of historical market price trends and price volatility.

Volatility is a statistical measure of the tendency of a market or security to rise or fall sharply within a period of time. Volatility is also a variable in option pricing formulas that denotes the extent to which the return of the underlying asset will fluctuate between now and the expiration of the option.

Key Concept: Historical vs. Implied Volatility

Historical Volatility The past standard deviation of a security that is used in security analysis. Standard deviation measures the changes in the past price of a security the higher the standard deviation the more volatile the security. The idea behind looking at historical volatility in security analysis is that it provides a measure of the future volatility of the security. For example, if the historical volatility of a security was high, meaning that the price varied a great deal over a period of time, then it might continue this volatility into the future.

Implied Volatility The estimated volatility of a security’s price over a given time period. In addition to known factors such as market price, interested rate movement, expiration date, and strike price, implied volatility is used in calculating an option’s premium. IV can be derived from a model such as the Black-Scholes Model.

Market Risk Factors

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Foreign Exchange - Credit Risk Factors

Group 24 HR 1 WK 2 WK 1 MO 3 MO 6 MO 1 YR 5 YR 10 YR

LOW VOL 0.6 1.4 2.0 2.9 5.1 7.1 10.1 22.6 31.9

MED VOL 1.1 2.4 3.4 5.0 8.7 12.3 17.4 38.9 55.0

HIGH VOL 1.2 2.6 3.7 5.5 9.6 13.5 19.1 42.7 60.4

Very HIGH VOL 1.6 3.4 4.9 7.2 12.4 17.5 24.8 55.5 78.4

Currency Pair Groups:

LOW VOL = USDHKD, USDCNY, USDTWD, USDSGD, USDPHP, USDINR

MED VOL = EURUSD, GBPUSD, USDDKK, USDMYR, USDIDR, USDCHF

HIGH VOL = USDCOP, USDJPY, USDCLP, USDMXN, USDKRW, USDCAD

VeryHIGH VOL= USDNOK, USDSEK, USDBRL, USDZAR, AUDUSD, NZDUSD, USDARS

Implied Volatility

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Risk Management Process

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Risk Management Process

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Step 1Formulate Risk Management

Policy

Step 4Formulate Hedging

Strategies

Step 5Execute Hedging Strategy

Step 3Determine

Budget Rates

Step 2Identify

Exposures

Step 6Evaluate Hedge

Performance (back to Step 2)

Case Study

Hedging a Foreign Acquisition

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Case Study – Situation Overview

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ABC Industries, a U.S. leading manufacturer of electrical components, recently agreed to acquire their largest competitor in the U.K. – XYZ Electronics.

Under the terms of the deal, ABC will pay 10 million pound sterling (GBP) in cash to acquire XYZ. ABC has budgeted a purchase price of $17,000,000 million.

The acquisition is expected to close in two months subject to due diligence.

Case Study – ABC’s Objectives

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Guaranteed protection. Establish a known worst-case USD cost for acquiring XYZ.

Cost-effective. Minimize up-front costs to hedge acquisition.

Upside potential. Retain ability to benefit if the GBP subsequently weakens against the USD.

Minimize breakage costs. Minimize potential liability in the event acquisition does not go through and hedges must be unwound.

Simplicity. Must be easy to explain to board and senior management.

Case Study – Hedging Strategies

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Currency Option Establishes a Known Worst-Case Rate But Retains Upside Potential

ABC can enter into a collar to establish a worst-case (cap) and best-case (floor) exchange rate for purchasing GBP.

Collar can be as wide or as narrow as you wish depending on your risk tolerance. Collar usually will be centered around current forward rate. Can be structured with no up-front fee. Protects against any strengthening of the GBP above the cap rate. You retain upside potential associated with a weakening of the GBP down to the floor rate.

Case Study – Summary of Hedging Alternatives

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Hedging Strategy

Guaranteed Worst-Case

Rate

Required Fee?

Upside Potential

Potential Breakage

Cost?

Forward Yes No No Yes

Option Yes Yes Yes No

Collar Yes Maybe Yes (limited) Yes

Case Study – Indicative Pricing

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Strategy:

Forward 1.6360

1.6348 GBP Call / USD Put $240,000

1.6675 GBP Call / USD Put $107,000

Zero-cost collar 1.6530-1.6110

Case Study - Graph

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Case Study - Outcome

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ABC entered into a collar option

Limited liability

Foreign Exchange Contracts

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Contract Description

Spot Exchange of currencies for value in one or two business days.

Forward Exchange of currencies for value on any valid business day beyond the spot settlement date. Rate based upon spot and the interest rate differential for the forward period.

Vanilla Option Purchased protection against rising currency (“Call”) or falling currency (“Put”).

Range Forward (a.k.a. Collar)

Protection against rising or falling currency values with a pre-determined range.

Forward Plus Protection against rising or falling currency values while retaining upside potential to some pre-determined level. (Contract will revert to a forward contract if the spot rate at maturity is trading beyond this level).

Participating Forward A zero-cost option strategy that locks in a worst case rate (100% protection at that level), while retaining upside potential on some pre-determined percentage of the notional.

Cross Currency Swap Interest rate swap that creates synthetic debt to match assets and liabilities.