The Telvent Company: Hedging Alternatives

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Introduction to Hedging in Relation to Telvent Company

Various scholars have described hedging differently. The different interpretations of the term depend on the scholar’s academic and professional orientations. However, many of these scholars agree that hedging is an investment technique that intends to offset potential losses or gains incurred by the company as a result of investing in a given portfolio (Hull 2009). What this means is that a hedge should reduce the severity of a loss that a multinational is likely to incur as a result of engaging in a given venture. In practice, hedging is used by multinationals faced by the threat of potential losses as a result of transacting in foreign currencies. The irony here is that the multinationals enjoy economies of scale. As such, many people will not expect such a company to face challenges normally associated with start-up companies.

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The focus of this paper is Telvent Company, which is a multinational entity that aims to venture into the volatile African market through Senegal. Telvent, a European based IT firm, was contracted by the Senegalese government to provide solutions for the country’s poor transport system. The poor state of the country’s transport system has led to, among others, heavy traffic jams and increased transport costs. The traffic congestion is not caused by lack of roads per se. On the contrary, it is mainly associated with the poor maintenance of the existing road network.

In this paper, the author analyses how and why Telvent company has adopted hedging. The analysis is made in the context of the company’s current venture into the African market through Senegal. The author settled for this company given its unique operation techniques. For example, the company is based in Spain, a euro country, but it is venturing into Senegal, a non-euro country. Such a venture is wrought with various risks, especially given the fluctuating currency rates in the global market. If Telvent Company has not adopted hedging techniques, the author will analyse the reasons for this. In addition, the author will critically analyse the reasons why the company should consider adopting various hedging strategies.

Hedgeable Risks

According to Valdez (2007), hedgeable risks are the types of threats that a multinational company can avoid through hedging. There are several types of hedgeable risks. Some of them are analysed in detail below:

Currency Risks

Multinationals are exposed to this risk since they deal with different currencies. Currency risk is brought about by changes in the global economy. The dynamics leads to different exchange rates for different currencies (Valdez 2007). In this case, Telvent is dealing with two currencies. The two are the Senegalese Franc and the Euro. The two economies are different, which means that they are affected by different market forces. The different market forces alter the exchange rates differently.

Credit Risks

Credit risk is related to the money owed, but not yet paid, to either a creditor or a supplier. Considering that Telvent has outsourced most of its financial services to financial institutions based in Europe, it is obliged to pay such debts. Failure to pay will lead to law suits, which may in effect cause delays in completing the project. In addition, the failure to deliver on time will deal a blow to the goodwill enjoyed by the company in the country.

Interest Risks

Interest bearing risk is associated with the value of a liability, especially a loan. If the economic interest rate increases, the risk is also likely to increase. As a result, there is need to hedge this liability (Lioui & Poncet 2005). The financial manager uses several strategies to manage this form of risk. One of the strategies involves the use of ‘interest rate swaps’.

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Equity Risks

Equity risks are those risks associated with the shares of a listed company. The risk is caused by dynamics in the stocks market. As a result, the investors may lose their money if the value of the stock depreciates (Saunders & Cornett 2006). The risk can affect the operations of Telvent, considering that it is a listed company.

Non-Hedgeable Risks

According to Valdez (2007), these are risks that cannot be hedged. It is not possible to hedge such risks considering that they are not caused by financial instruments. In most cases, non- hedgeable risks are caused by non-financial activities. Some of them are analysed below:

Political Risks

In spite of the fact that Senegal enjoys a fairly stable political environment, political hostility may arise any time. Such hostilities may arise when rival politicians engage in war. The hostilities are likely to affect the success of the project in a negative way. In some cases, court battles may arise. The company will waste a lot of resources settling such cases. Another risk that falls into this category involves actions taken by members of the public against the company (Saunders & Cornett 2006). The actions include, among others, vandalising raw materials and public demonstrations against the company. This will disrupt the operations of the company. According to Kurtz (2010), it is not possible to hedge political risks.

Risks Associated with the Company’s Human Resource

To succeed, Telvent needs a motivated workforce. The work force should possess specific talents to perform the activities needed to successfully complete the project. The company may face challenges acquiring a labour force with the required qualifications. As such, Telvent may opt to recruit trainees who may ruin the success history of the company. Kurtz (2010) is of the view that industrial action does more harm than good to multinationals. If the employees take industrial action against the company, it may be forced to put on hold some of the activities. The major explanation for this is that employees who engage in industrial action in Senegal cannot be fired. The provisions of the country’s labour laws protect such employees.

Hedging Options at the Disposal of the Company

There are various financial alternatives at the disposal of Telvent Company. The alternatives include, among others, exchange traded fund, forward contracts, money market hedging, swaps, and options. Since Telvent is a multinational firm, the best hedging options are forward contract, future contracts, options, and swaps. Such ‘swaps’ include currency swaps.

Future Contracts

According to Hull (2009), this technique is also known as money market hedging. It involves a standardised contract between two parties in a given transaction. The parties agree to sell or buy an asset with specified qualities at specified quantities and at a given price. In this case, payment is made when the asset is delivered. In most cases, the contract is negotiated using future exchange rates. Valdez (2007) defines future exchange rate as ‘the intermediary time before the buyer receives the good and the seller releases the good’ (p. 56). During this period, the buyer hopes that the price of the asset in the market will increase. On the other hand, the seller hopes that the price of the asset in the market will decrease. Telvent Company uses future contract to purchase commodities and assets. Examples of such assets include, among others, securities and currencies. In addition, the contract is used to purchase intangible assets, such as interest rates and stock indices.

Telvent stands to benefit from the adoption of this technique. The various agreements are drafted between the parent company and the branch in Dakar, Senegal. The company remains exposed to foreign exchange risks. The exposure is significant given that Telvent is borrowing funds from either an individual financing agency or a consortium. The project is very important as it will determine the future of the company. As a result, the company will work hard to make it a success. Foreign exchange risk is addressed by designing future contracts when and where appropriate. Future contract is used as a short term hedging instrument for Telvent Company.

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Currency Swap

According to Lioui & Poncet (2005), currency swap is a contractual agreement between parties. The parties agree to exchange a principal amount of two different currencies. Under a currency swap arrangement, the company enters into an agreement with a specified expiry date. When the term of the contract expires, the original principal is refunded. Interest on each of the currencies is paid throughout the life of the agreement.

According to Kurtz (2010), the agreement is also known as fixed rate currency swap. Telvent Company will use this technique to address the currency risk. However, the company is required to make additional payments to cater for fluctuations in interest rates. The arrangement is different from the interest rate swap, which lacks a fixed ‘notional’ principal to be paid. Telvent Company is aware of the principal it is required to pay at the end of the agreed period.

Fixed rate currency swap helps the company to determine the amount of money that is due for payment. As a result, the company is able to plan for this amount of money. The arrangement is different from the ‘basis’ rate, where the party is only aware of the amount payable on different maturity dates. Basis rate is disadvantageous to a multinational, especially when the company is going through harsh economic times.

Conclusion

In order to reduce potential losses, Telvent Company has decided to hedge risks that are ‘hedgeable’. For example, the company will hedge risks associated with currency volatility, equity transactions, changes in interest rates, and credit liability. The aim is to mitigate the negative impacts the risks has on the company. However, there are risks that cannot be hedged. They include political risks and those related to human resource.

To address the hedgeable risks, Telvent Company has settled for two hedging techniques. For short term purposes, the company will employ futures contract technique. The technique will cater for urgent transactions. For long term purposes, the company has adopted fixed rate currency swap. There are various benefits associated with the fixed rate currency swap. The arrangement uses a fixed amount of principal. In addition, the arrangement has a fixed rate of interest. The interest rate is charged on the transactions carried out.

References

Hull, C 2009, Options, futures and other derivatives, Prentice Hall, New Jersey, USA.

Kurtz, D 2010, Contemporary human resource management, Cengage Learning, South-Western.

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Lioui, A & Poncet, P 2005, Dynamic asset allocation with forwards and futures, Springer, New York.

Saunders, A & Cornett, M 2006, Financial institutions management, McGraw-Hill Irwin, Chicago.

Valdez, S 2007, An introduction to global financial markets, Macmillan Press, Basingstoke, Hampshire.

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