Loans are by nature sources of change
Partnerships are by nature a source of change, so you’ll want to identify what might cause you stress in a partnership as soon as possible. The checklist in Exercise 4 will help you determine which of the most common stress points in a partnership affect you most. The statements you mark “yes” indicate areas that are likely to cause you some anxiety when it comes to change. If you dislike giving up control when performing a task, for example, you probably feel stress in a partnership when you have to do a task together. The anxiety you feel is the aftermath of the change you’re experiencing. You may try to avoid or even deny the change to prevent the anxiety—this is the normal “fight or flight” response we all experience during periods of stress.
If we can’t control the change that’s occurring around us, at least we can recognize the stressors and develop a plan to deal with them. Knowing your stressors and how you react to change is important in helping you cope with change.When two people or two organizations come together, things are bound to be different.
Assessments of an issuer’s credit quality
The rating agencies have been criticized for being too slow to react to changes in the credit quality of an issuer, leading to serially correlated rating patterns and limiting the value of ratings as a risk management tool. As a reaction, Moody’s decided to put its rating process under review, and acquired KMV to be able to provide investors with additional, marketbased assessments of an issuer’s credit quality. The feedback from market participants was surprising. Since investors themselves tend to use spreads and spread volatility as indicators for credit risk, the vast majority does not want Moody’s or the other rating agencies to switch to a more marketbased approach when assessing the credit quality of an issuer. There is really a need for, according to the feedback, more transparency with regard to the rating process. This would allow investors to use rating agency information in their risk management most efficiently.
The impact of credit on operating income
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.
When payday translation risk arises
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.