Treasury Risk

Management

Macro Trends and the

Implications for Corporations

Andre Secron

Head of Foreign Exchange Corporate Sales

and Structuring

Latin America

andre.secron@citi.com

+1 (212) 723-1351

Treasury and Trade Solutions

1. Market Trend—The Strong US$ Cycle

2. The Implications of the Strong US$ for Corporations

3. Considerations for Hedging Policies

4. Key Takeaways

1. Market Trend—The Strong US$ Cycle

2. The Implications of the Strong US$ for Corporations

3. Considerations for Hedging Policies

4. Key Takeaways

70

90

110

130

150

1973 1978 1983 1988 1993 1998 2003 2008 2013 2018

History Suggests Continued Dollar Appreciation in Current Cycle

Since the inception of floating currencies, peak-to-trough cycles in the US$ have lasted between 6–9 years. With potentially 3–6 years remaining in current cycle, US$ may

strengthen by a further 10–30%. And while cycles may revert eventually, the long-run may encapsulate significant volatility impacting current performance.

US$ Since 1973

US Traded Weighted Real Major Currencies Dollar Index

6–7 years

60% (7.5% ann.)

7–8 years

(40)% (5)% ann.)

6–7 years

60% (7.5% ann.) ~9 years

(33)% (4)% ann.)

Current Cycle

Potentially 3–6 years

Remaining Potential 10–30%

US Corporations Benefited

Greatly from the Previous

9 year Cycle of US$ Weakness

Source: Bloomberg.

4

US$ Appreciation Projected Across the Board

Source: Bloomberg, Citi GEOS.

Note: Projections based on Citi FX forecasts. Market data as of 1/19/2015.

DM Currencies EM Currencies Commodity Currencies

10.9%

-0.6%

3.3%

-0.6%

2.6%

-6.6%

3.9%

0.4%

16.1%

13.7%

7.4%

11.6%

8.8% 8%

10% 10%

7.1% 7.1%

Current 3.22 634 15.1 2590 1.08 121 1.49 0.77 1.26 1Y Forecast 3.57 655 15.5 2690 0.93 130 1.37 0.7 1.35

Long Term 3.2 630 14.1 2600 0.95 135 1.38 0.7 1.35

MXN

5

US$ Appreciation within Latin America Context

Source: Bloomberg.

80

100

120

140

160

Dec-1

2

Ja

n-1

3

Ja

n-1

3

Feb-1

3

Feb-1

3

Ma

r-13

Ma

r-13

Apr-

13

Apr-

13

Ma

y-1

3

Ma

y-1

3

Ma

y-1

3

Ju

n-1

3

Ju

n-1

3

Ju

l-1

3

Ju

l-1

3

Aug

-13

Aug

-13

Sep

-13

Sep

-13

Oct-

13

Oct-

13

Nov-1

3

Nov-1

3

Nov-1

3

Dec-1

3

Dec-1

3

Ja

n-1

4

Ja

n-1

4

Feb-1

4

Feb-1

4

Ma

r-14

Ma

r-14

Apr-

14

Apr-

14

Ma

y-1

4

Ma

y-1

4

Ma

y-1

4

Ju

n-1

4

Ju

n-1

4

Ju

l-1

4

Ju

l-1

4

Aug

-14

Aug

-14

Sep

-14

Sep

-14

Oct-

14

Oct-

14

Oct-

14

Nov-1

4

Nov-1

4

Dec-1

4

Dec-1

4

Ja

n-1

5

Ja

n-1

5

Feb-1

5

Feb-1

5

Ma

r-15

Ma

r-15

USDBRL USDCOP USDCLP USDMXN

6

US$—The Multi-Year Bull Trend: Why?

Stronger Expected US

Economic Growth

Declining unemployment rate (under 6%)

Strengthening activity in industrials and

service sectors

Improving personal consumption

expenditures

3% forecasted GDP growth in 2015–2016

Divergence in Central

Bank Action

Sustained US economic recovery

supporting US Fed tightening

Persistent sluggish growth in Eurozone and

Japan supporting further easing

Unexpected central bank actions (i.e.

removal of EURCHF floor) drive volatility

Lower Oil Prices

Oil producing countries experiencing

declining revenues, increasing budget

deficits, and adverse exchange rate impact

Slowdown in Expected

EM Growth

China’s slower transition towards a

domestic consumption driven economy

Broader EM headwinds due to current

account deficits

GDP growth slowing to low 7% in China

Expectation of Sluggish Growth

in Eurozone and Japan

Persistent low/negative inflation despite

unprecedented easing

Weak labor markets with

structural challenges

Stronger

US$

7

1. Market Trend—The Strong US$ Cycle

2. The Implications of the Strong US$ for Corporations

3. Considerations for Hedging Policies

4. Key Takeaways

Strong Dollar Already Affecting Corporates

Our largest exposure remains the euro. […] we’ve hedged

roughly 50% of our 2015 euro exposure […] Considering

these impacts, FX will be a sales headwind for 2015 [ … ],

which works out to about $0.10 per share.

Dollar’s rise against the ringgit was partly to blame for

lower quarterly revenues. About 70% of the company’s

debt is in U.S. dollars, and its bond yields spiked as the

ringgit fell nearly 9% in the past six months.

3M estimates that year-on-year currency effects, including

hedging impacts, decreased net income attributable to 3M

by approximately $10 million for the three months ended

September 30, 2014.

The net income and EPS include a charge of EUR 180

million from negative FX revaluation in the third quarter

due to the strong strengthening of the dollar. […] we

increased the pace of hedging activity due to the favorable

dollar environment.

Source: Bloomberg.

9

Stronger US$ Impacts Multiple Corporate Dimensions A stronger US$ impacts corporates across the financial statements, potentially pressuring margins, overseas valuations, and the

ability to compete in the future. Prudent risk management can help to mitigate these concerns.

Timing mismatch between contract and payment in a foreign currency

Competitor pricing

Lower channel costs

Mismatches between sales in one currency and costs in another currency

Market volatility as well as uncertainty in revenues

Foreign-based subsidiaries may create earnings volatility

Can impact earnings per share (EPS), credit ratings and cost of capital

Potential covenant breaches

Interest cost can be minimized

Match currency exposure of cash flows (CF) and net assets

Protecting shareholder’s investments in foreign subsidiary

Expected repatriation of overseas cash

Increasing global footprint

Potential cross-border acquisitions

Internal investment: Predicable cash flow = more investment

Sufficient liquidity

Operational

Financial

Economic/Strategic

Transactional

Cash Flow

Operating Earnings

Debt/Liabilities

Assets

Business Growth

Competition

Capital

Income

Statement

Balance Sheet

10

Who are Most Impacted?

Multinational Corporates

US multinationals with significant

sales abroad will see their foreign

cash flows erode

Non-US multinationals with US

revenue exposures will benefit from

stronger US$

Non-US multinationals that fund in

US$ will see negative impact on their

balance sheet as US$ strengthens

US$-Funded EM Corporates

EM multinationals with large US

revenue exposures will benefit from

stronger US$

EM multinationals that fund in US$

will see negative impact on their

balance sheet as US$ strengthens

Global Commodity Producers

While revenues of foreign oil

producers will decrease due to falling

oil prices, a stronger US$ will

mitigate the negative impact

US producers will benefit from

lower foreign production costs as

US$ strengthens

Careful analysis is key to

understanding how FX/commodity

correlation impacts corporate top and

bottom lines

11

1. Market Trend—The Strong US$ Cycle

2. The Implications of the Strong US$ for Corporations

3. Considerations for Hedging Policies

4. Key Takeaways

Traditional Hedging Programs Static Hedging Program

Hedges for the entire year implemented at one single point

in time

Rolling Hedging Program

Hedges are implemented throughout the year as new forecasts

become available

Provides predictability of the value of future transactions over a

defined period of time

Layered Hedging Program

Similar to a rolling program in that hedges are implemented

throughout the year

However, in an effort to create smoothing the hedge ratio is

built-up over time

Static Hedging Program

Rolling Hedging Program

Layered Hedging Program

13

A Customized Solution to Protect Against US$ Strength

Front-loading the hedging schedule to increase value at risk (VaR) reduction

Adding options to the mix of hedge instruments to maintain the flexibility lost from front-loading. This is particularly important as the

strengthening in the US$ is unlikely to be in a straight line over time

Standard Layered Hedging

Dynamic Layered Hedging

Extending hedge duration

14

Portfolio Diversification Portfolio diversification can be a powerful tool to stabilize the performance of a hedging portfolio. In particular, the strategy is highly

effective in periods of increased market volatility.

CitiFX ran a backtest analysis of the hypothetical performance of four different hedging strategies and an unhedged portfolio

The simulation assumes a quarterly rolling hedging strategy. Follows ahead the results of the combined portfolios

Hedging

Period

FX Spot at

Beginning

FX Spot at

End Forward Strategy A Strategy B Strategy C Portfolio1 Portfolio 2

1Q13 13.68 12.61 13.92 13.64 13.50 13.92 13.16 13.42

2Q13 12.96 12.27 13.21 12.95 12.82 13.21 12.64 12.81

3Q13 12.61 12.62 12.84 12.59 12.46 12.62 12.58 12.57

4Q13 12.27 12.99 12.46 12.39 12.99 12.55 12.88 12.73

1Q14 12.62 13.51 12.83 12.68 12.44 12.90 13.09 12.88

2Q14 12.99 13.11 13.17 12.90 12.77 13.11 13.02 12.97

3Q14 13.51 12.96 13.69 13.42 13.28 13.69 13.22 13.34

15

Portfolio Diversification (Cont’d)

12.00

12.50

13.00

13.50

14.00

1Q 2013 2Q 2013 3Q 2013 4Q 2013 1Q 2014 2Q 2014 3Q 2014

FX Spot at End Forward Portfolio1 Porfolio 2

FX Spot at End Forward Strategy A Strategy B Strategy C

Portfolio 1 50% 0% 0% 25% 25%

Portfolio 2 25% 0% 25% 25% 25%

16

1. Market Trend—The Strong US$ Cycle

2. The Implications of the Strong US$ for Corporations

3. Considerations for Hedging Policies

4. Key Takeaways

Key Takeaways—Risks, Implications and Solutions

Risks

Implications

Solutions

Widening growth prospects between US and rest of world, and sustained divergence in central bank policies will

drive US$ stronger in current cycle. Meanwhile, corporates have become more global with a higher percentage

of revenues coming from overseas

Exposure to FX risk is a predominant driver of earnings volatility, while changing volatility and correlation

dynamics today may negatively impact corporate earnings

The turn of US$ cycle from weakness to strength requires corporates today to review and adjust their risk

management strategies

Holistic assessment of a corporate’s market risk exposures that takes into consideration correlation and volatility

dynamics are critical to effective risk management

Effective risk management can potentially boost valuation and improve growth prospects. Corporates should

adjust hedging strategies and capital deployment policies in today’s strong US$ cycle

Stronger US$ may affect corporates in multiple dimensions, with implications on cash flows, balance sheets, and

business strategies

The implications vary for different types of global corporates, depending on their market risks exposures

Many corporates have reported negative impacts from US$ strength in recent quarters with potential for more

downside risk in coming quarters

18

Key Takeaways—Tangible Results

“…dollar COGS hedge is the most “attractive” in several years. A second factor is, following Citi’s recently revised f/x estimate, the value of

Ambev’s dollar COGS hedge for 2015 has increased significantly. This is true both for its own earnings growth potential as well as relative

to its beverage peers (brewers and bottlers alike) who either can’t hedge their dollar-linked COGS against a weaker f/x or hedge less

effectively. We incorporate Citi’s average 2015 real/dollar f/x estimate of R$2.83 (from Jan/26), 13% weaker than the estimate in October

(before the elections), implying a 20% depreciation YoY. More importantly, this average market rate is well above our assumption of an

average R$2.35 for Ambev’s 2015 dollar COGS hedge in Brazil, which we believe no other beverage peer has. R$2.35 implies a 7%

weaker hedge than 2014 (when it was 15% higher YoY), suggesting less pressure compared to prior years. The benefit of the hedge is

partly offset by less favorable commodities hedge this year versus last year.”

Alexander Robats, Head of Citi's Latin American Consumer Staples Equity Research team. In the Food/Beverage/HPC sectors –

January 28th, 2015

“Based on a less onerous beverage tax (see note), more than expected Brazil margin expansion, recent sharp currency

depreciation (increasing the value of its dollar COGS hedge), and an undemanding valuation, we argue Ambev’s de-rating is over

and upgrade to Buy.”

19

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