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European telecom companies have their operations primarily in Europe. Therefore, exposure to foreign currencies is very limited with the exception of Telefonica’s exposure to Latin America and Deutsche Telekom’s US subsidiaries. While in other industries an appreciating Euro increases competition, it appears that this effect should be negligible for the established European telecom services companies. The barriers of entry seem to be high enough to guarantee broadly stable market shares in the coming years. Since many of the telecom companies have a material fraction of their debt in US dollars, they would benefit from a strengthening Euro.

It is in the nature of financial institutions to have exposure to a variety of currencies. Exchange rate risk is therefore translational rather than transactional. By and large, long-term currency risk is primarily taken in the form of subsidiaries. Currency fluctuations change the value of the equity invested, hence are reflected in the balance sheet rather than in the P&L. Of the larger European banking groups, ABN Amro, BNP Paribas and Royal Bank of Scotland have substantial retail banking operations in the United States. In the insurance sector, Aegon, AXA, ING Verzekeringen and Prudential stand out in terms of US exposure.

The paper sector is only mildly exposed, since in general companies generate no more than 20 percent of their revenues in the United States. The more internationally oriented technology and chemical companies like Siemens, Philips and Akzo generate about 30 percent of sales in the United States, and have substantial further sales outside the Euro area. Yet, the impact on operating income is reduced by the fact that a significant part of costs accrues in US operations. Additionally, most industrial companies engage in hedging activities. Among the companies with a high exposure to currency risk are UK companies FKI and Pearson that both generate more than 60 percent of sales in the United States. When the US dollar depreciates significantly, these companies are hit hardest.

With respect to their vulnerability against currency movements, companies from the consumer sector benefit from their broad geographic diversification.

It appears to be common policy to match assets and liabilities in the various regions to minimize overall currency risk. However, while transaction risk is accounted for, companies tend to leave translation risk unhedged. But many of the well-known European consumer companies like Nestle and Unilever have been able to raise funds in US dollars. Thus US dollar denominated debt exceeds assets and earnings. During the US dollar weakness those companies have seen their debt and interest burden diminish faster than their earnings. UK tobacco companies tend to finance a significant part of their business with Euro denominated debt, leaving them exposed to a strengthening of the Euro versus Sterling.

Being one of the most global sectors, the automotive sector is particularly exposed to currency movements. Significant changes of major exchange rates therefore may have a material impact on earnings. Yet, some manufacturers are better positioned than others due to a number of factors that do not only relate to natural or derivatives hedging. Awell-filled model pipeline, restructuring plans, cost reduction issues and a high degree of flexibility in the use and sourcing of raw materials and intermediate goods may outweigh negative effects due to currency fluctuations. With regard to transaction risk, those companies that have no foreign exchange exposure or are hedged, either naturally or through derivatives, clearly have the lowest risk. In terms of translation risk, companies whose assets and liabilities are well matched have the lowest risk and will have the lowest volatility of operating profits.

During the 2002/03 US dollar weakness, revenues and to a lesser extent operating profits of most European industrial issuers suffered significantly due to substantial US operations. However, exposure to US markets varies across industries.

The third effect of currency fluctuations refers to the fact that the appreciation of the local currency attracts imports from abroad. Usually, the import competition effect only becomes apparent, when the currency appreciation has been sustained for some time. While companies are quick to cite the impact of exchange rate movements on revenues, profits and liabilities, the longer term effects with regard to market share and prices are hard to quantify.

Ultimately increased competition through cheaper imports can cause earnings erosion in the domestic markets. On the other hand, European car makers benefited from the weak Euro in 2000 and 2001 through increased exports to the United States.

Although in the age of globalization, currency fluctuations may have an impact on most companies earnings, some sectors are more vulnerable to the currency issue than others. In general, the industrial, and here most notably the capital goods sector, and the automotive sector are particularly exposed. Especially from a longer perspective, the impact varies on the company level, when (natural) hedges are taken into account. While the European utilities and telecom sector have a relatively low exposure to the US dollar, they are more impacted by fluctuations of emerging market currencies.

When financial accounts are converted from one currency to another, translation risk arises. Typically, the financial accounts of foreign subsidiaries have to be translated back in the reporting currency to be included in the consolidated financial accounts. Since most companies do not hedge translation risk, significant changes in exchange rates during the reporting period can cause volatility in revenues and operating income. Usually companies present constant exchange rate revenues as an addition to reported revenues, to allow investors and creditors to analyze the effect of currency fluctuations.

However, a secular depreciation of the US dollar positively affects those European companies with part of their liabilities denominated in US dollars. Not only the amount of debt shown on the balance sheet is reduced, but also the associated interest burden is lessened. In terms of credit ratios, the issuance of debt in a currency, in which part of the revenues are generated, can provide an effective natural hedge against exchange rate volatility. For example, if profits of a European company operating in the United States were reduced by a weakening US dollar, it may be offset by a contemporaneous reduction of the level of US dollar denominated debt. In this case, credit ratios as well as interest coverage ratios could remain constant or even improve. It should be noted that revenues and earnings typically accrue gradually, hence they are translated at average exchange rates, while balance sheet figures are usually determined at the end of reporting period spot rates.

Transaction risk arises when a company has a currency mismatch between its costs and revenues, that is, revenues are generated in one currency while costs are denominated in another, the reporting currency. The sustained depreciation of the US dollar since February 2002, for example, has negatively affected the P&L and cash flow statements of European exporters.

Although it proves difficult to obtain a breakdown of the cost structure of a company by currency, the automotive sector and the aerospace sector seem to be hit most by transaction risk.

Therefore, many companies try to offset at least a part of their currency exposure via natural hedging. That is, they try to match currency flows that result from exports and imports of goods and services. A high degree of flexibility with respect to input factors and capacity utilization of plants in different regions also provides an effective hedge against adverse currency movements. Another possibility of reducing currency risk is through derivatives, primarily forward exchange contracts and currency options. In our experience most companies that are significantly exposed to currency risk use some form of derivatives hedging. Yet, most contracts are set up for a period of 1–2 years at most. In the long term, it is difficult for companies to assess their demand for hedging because they have no reliable information
about the future demand for their products and services so that the future cost and earnings situation is unknown. For longer term trends in exchange rates, natural hedging usually is more effective. Credit analysts often lack a thorough insight in currency hedging strategies, especially with regard to derivatives hedging. Since they are hardly able to assess the true currency exposure in the short term, they tend to prefer the longer term and more transparent natural hedging strategies.

Credit spreads are also affected by fluctuations of exchange rates, with the USD/EUR exchange rate being the most influential one. The depreciation of the dollar that started in 2002 could potentially affect European corporate issuers if it slows economic growth and reduces demand for their products.

However, a rise of the euro against the dollar could move the ECB to cut rates and thus would impact credit spreads via the interest rate channel. The dollar weakness is mainly due to a large current account deficit, low levels of interest rates and slowing equity capital inflows. Of course, sustained fluctuations of exchange rates can impact the business of corporate borrowers as well as financial institutions. While this does not necessarily lead to significant changes in credit quality and subsequent rating actions in the short term, especially companies with a weak financial profile may find the currency issue an unwelcome challenge. A forward-looking active currency management may be based on three main factors: US inflation, European growth and comments from policymakers. However, many companies are not able or willing to manage their currency exposure actively. In this case, significant changes in exchange rates will affect companies in three ways: via transaction risk, translation risk and import competition risk.

Comfort zone investing consists of knowledge of how different investments affect your emotions, knowledge of who you are in relation to investments, and choosing investments that match your personality. The comfort zone is tested most often by large increases and decreases in investment values. Studies of stock investors show that most investors react to declines in stock values by holding on too long-hoping the price will improve. Investors also sell winners too soon to lock-in profits, missing even greater gains, and avoid purchases of bargain stocks that have declined in price fearing the declines will continue indefinitely. The net result is individual and professional investors consistently fail to make even half the stock market averages.

Many studies describe these phenomena. These self-defeating behaviors are attributed to thinking patterns such as “loss aversion,” the “disposition effect,” and “mental accounting.” Unfortunately, the studies only describe the patterns and the resulting low returns. The studies do not tell you why you are reacting dysfunctionally nor how to act maturely.

This book answers both questions. The comfort zone has three elements: self-knowledge, investment knowledge, and matching yourself to the proper investments. If any of these three elements is out of place, your reaction to your investments will be dysfunctional. If you are in the right investments, you will act maturely. For example, many investors think that investing is solely about numbers. Unfortunately, focusing on numbers ignores both who you are and the nature of investments.

Thanks to advertising, mergers, and co-branding of certain company logos, it’s hard to separate the major credit card companies from the “fly by night” operations. This is a critical distinction because the larger companies generally work harder to keep their customers and investors happy, as well as stay in the good graces of regulators. While the term “American Express” really refers to just one company, the terms “Visa” and “MasterCard” are used by numerous institutions with varying policies and rules.

When you evaluate which credit cards to keep and potentially use, it’ll likely be a card from one of the larger companies, without a lot of the fancy features. It’ll simply be a low or no annual fee credit card that you use to do things like book airline tickets. These cards should also have a reasonable annual interest rate, but don’t get too hung up on that. Your goal is to pay it off in the same month you make a necessary purchase.

When it comes to debt problems, credit card debt is the granddaddy of them all. According to CardWeb.com, the average American had $9,900 in credit card debt in 2007. In addition, 61% of credit card users do not pay off their balance each month, with 13% carrying a balance of at least $25,000. If it weren’t for credit card payments, many people would be able to successfully deal with an increase in their mortgage, the addition of a car payment, or the temptation to buy that new “thing.” It’s very likely that your unique battle to get rid of unhealthy debt will center around the elimination of your credit card balances. But, as you’ll see, whether or not you eliminate them is affected by how and when you continue to use them. And how and when you continue to use them will be impacted by your budget and spending plan.