Risk Management Policy in International Business Machines Corporation - Research Paper Example

? Corporate Research Paper - Company: IBM Introduction: International Business Machines Corporation (IBM) is one of the leading industries providing services regarding Information Technology (IT), financial, public, industrial, distribution, communications, general business, lease and loan financing etc. One of its latest innovations includes “New Water Management Program for Netherlands” as on Jun 25, 2013. The company has its business operations flourishing in more than 170 countries, and it also has 70 branches and subsidiaries in total. The branching out of the company leads to international geographic allocation of profits for IBM. Recently, the firm has started its operations in Ghana, Nigeria, Angola, Kenya, Senegal and Tanzania in Africa. It has investments in training units, data centers, offices and other amenities. IBM has now extended its branches further in Latin America, Asia and Eastern Europe by establishing research labs worldwide. Brazil is another country that IBM has expanded its business operations to, and the company believes its business there will be a huge success. IBM is actively participating in conducting “World Cup in 2014”and “the Olympic Games in 2016” by offering transportation, communication services etc. IBM Global is involved in activities such as various investments, financing assets, leverages with debt and managing the related risks. Its total income from sales as on March 2013 is 103.2 billions$. About Exchange (FX) Risk Management Policy in IBM: According to Cassio Calil, the Assistant Treasurer and Head of Global Operations, the IBM global forex risk management operation has been incorporated under one group worldwide. Therefore, no hedging activities are done outside the United States except sometimes in Dublin, Brazil and NDF [non-deliverable forward] market. Dublin acts as IBM’s money operations center for Europe along with offering cash to its subsidiaries worldwide. The euro, pounds sterling and yen are considered as the biggest forex exposure of IBM. IBM manages different exposures on interest rate, foreign exchange, credit, and equity. IBM hedges these exposures with forwards, average strike forwards and double average rate forwards. The equity price changes in accordance with market price fluctuations in equity market indices and in common stock of IBM. This change in turn is related to employee compensation obligations given under the head, SG&A expense in the consolidated statement of earnings. IBM uses forward contracts, futures, interest-rate and currency swaps, Cash Flow, Fair Value and Net Investment Hedges etc in accordance with the basic exposure mentioned above. The hedging transactions of IBM include debt risk management, long-term investments in foreign subsidiaries (net investment), anticipated royalties and cost transactions, subsidiary cash and foreign currency asset/liability management, and equity risk management. Hedging Transactions used by IBM: Debt risk management: IBM provides debt in worldwide financial market in order to account its financing lease and loan portfolio. This sometimes might lead to a hike in rate of interest or a disparity in currency with the assets. To solve these issues, IBM makes interest-rate swaps to convert particular fixed-rate debt into variable-rate (or “floating-rate”) debt (i.e., fair value hedges), and it also converts specific variable-rate debt into fixed-rate debt (i.e., cash flow hedges). The currency disparity takes place regarding foreign currency denominated debt, whereas the interest rate instability happens with forecasted debt of IBM. To correct these risks, the company uses cross-currency swaps and forward starting interest-rate swaps and enters them as cash flow hedge transactions. Long-term investments in foreign subsidiaries (net investment): Due to the fluctuation in foreign exchange rates in the functional currencies of the foreign subsidiaries when compared to USD, the foreign currency denominated debt head is accounted as a net investment hedge. This in turn affects the stability of the shareholder’s equity. To manage this risk, the company uses cross-currency interest rate swaps and foreign exchange forward contracts. Anticipated royalties and cost transactions: The revenue of IBM includes non- functional currency from non-US Subsidiaries, payments from third parties for royalties and good and services, and intercompany payments with its parent company. Expecting a forex fluctuation in non-functional currencies, the company has adopted the foreign exchange forward contracts to manage such risks. These are explained as cash flow hedges and it usually takes a maximum of four years to bring them into the statement of future cash flows. Subsidiary cash and foreign currency asset/liability management: IBM uses its worldwide central bank and its branches to manage and disburse the liquidity of its subsidiaries. It uses currency swaps to convert cash flows and foreign exchange forward contracts of six months to hedge the forex fluctuation portion of the company’s nonfunctional currency assets and liabilities on a net basis. Any fluctuations in fair values of these contracts and the hedged exposures are recorded under the head “other income or expense” in the Consolidated Statement of Earnings. Equity risk management: There are chances of changes in price in equity shares held by the employees in IBM. These are the result of changes in market price indices and common stock of IBM. This total fluctuation in the value of employee compensation is accounted as SG&A expense in the Consolidated Statement of Earnings. To hedge the exposures relating to employee compensation obligations, the company uses equity derivatives, including equity swaps. It uses such derivatives to arrive at a gain or loss on fair value and to report the same in the Consolidated Statement of Earnings. The Use of Derivatives for Funding, Investing, and Other Price Risks: As the company receives different functional currencies from non-US subsidiaries, it is exposed to fluctuation in forex rates, interest rates, equity price and credit risks. This also affects the global borrowing and lending activities of IBM. To manage these risks, the company follows risk management policies and procedures like derivatives. Uses of Derivatives: Derivatives are used to manage the cost of debt. Derivatives are used in both foreign currency and interest rate exposures. In case of foreign currency exposure, derivatives are used to reduce the effects on financial currencies that may occur as a result of forex fluctuations in financial statements. In case of interest rate exposure, they are used to monitor the changes in interest rates of lease, debts and funding assets. IBM uses derivatives for hedging the instability in shareholder’s equity due to forex changes. IBM uses some deemed derivatives like warrants of certain investments in such cases. These warrants include net liquidity payment options. IBM accounts the difference in fair value of these warrants under the head “other (income) and expense” in the Consolidated Statement of Earnings. IBM uses credit derivates to manage the risk of counterparties due to forex fluctuation. IBM’s Offshore and Euro Market Funding and Investment Activities: Thomas Watson predicted that “The United States has six percent of the world’s population, and the rest of the world has ninety-four percent: someday the World Trade Company is going to be larger than the US company.” His prediction encouraged the company to start operations in different countries including the ones in the European continent, which lead to an increase in the foreign sales turnover to IBM. France was the first foreign country outside the United States to start the business operations by IBM. The European headquarters for IBM was first established in Paris, and then shifted to Geneva by Watson. The company is invested in aircraft business with Japan, machinery, road, rail, transport, information technology, manufacturing plant etc with other foreign countries. Conclusion: IBM is considered as one of the best risk management consultants in the world. It has set up IBM risk and financial management practice for all its industries. Its consultants are experts in research and development as well as other services provided by the company where they interact with clients and render the finest services. IBM follows SWOT analysis to determine its international financial strategy. This shows the company’s strength, weakness, opportunity and threats in the business. Its strategy includes calculation of financial ratios to find out its profit, returns, liquidity, leverage, financial position, revenue trends etc and compare the same with its competitors. These financial strategies help to identify and anticipate the reasons of decline in revenues as well as fid out ways to operate the business activities in order to maximize profit. IBM is considered as a great leader in value creation, which is due to the fact that it follows a unique method in creating value and developing strategy. It undertakes a different approach from that of its competitors and aims for more profit as well as succeeds in its goals too. To avoid similarities in products with other companies, IBM tries to create and develop new products techniques, strategies for new challenges, delivery accuracy, top quality solutions etc. This performance by IBM creates market value for its products and services globally all the time. IBM is known for its firm position in business software, services, and hardware. The market value of total capital of IBM is calculated as follows: The value of assets in place, [Va] or, the value of the current operations (i.e. the discounted value of the current net operating profits) + the value of the future growth opportunities [Vg]. This signifies that “the greater the market value of the total capital of the corporation is composed of the value of the current operations [Va], the less significant is the value of the most uncertain part of the total value, i.e. the future growth opportunities [Vg]”. The Intrinsic Value of IBM is 233$ and its recent price is 203.24$(in millions). For IBM, the market value is composed of the value of current business operations, which is also the predicted value. The market value is created or destructed by finding out the difference in market value added over the past years. Market value added will increase if the value boosts by more than the amount of new capital added to the business, and vice versa. This concept helps in deciding to invest in a specific stock and also helps to determine if the stock is worthy or not. Market Value Added (as on March 9, 2013) (in Millions$) Market Value of Total Capital is 214,890.61$ Invested Capital is 111,499.26 $ Market Value Added is 183,391.35 $ The over confidence on estimation of intrinsic value is considered as the reason for the destruction of value of IBM. Also, there is a decline in the hedging activities of IBM according to recent reports, which is mostly as a result of insider trading interest. For the last six months, International Business Machines Corp (NYSE:IBM) has experienced “zero” unique insiders purchasing, and “17” insider sales. By continuing to utilize financial strategies like financial ratios, SWOT analysis and corporate strategy, the company will further develop as a good business advisor for risk management, financial services and other market challenges. Its business consultants help the clients by offering solutions to the finance issues, formulating finance and risk management strategies, providing new business models etc. Works Cited Global Data. "International Business Machines Corporation (IBM) - Financial and Strategic SWOT Analysis Review." International Business Machines Corporation (IBM). Marketresearch.com, 3 July 2013. Web. 15 Aug 2013.  http://www.risk.net/risk-magazine/feature/1526691/ibm-covering-angles IBM. "Notes to Consolidated Financial Statements (audited)International Business Machines Corporation and Subsidiary Companies." IBM 2008 Annual Report: L. Derivatives and Hedging Transactions. IBM, n.d. Web. 15 Aug 2013.  Pierre, Jacques Saint-. "IBM: The Future Is Bright." International Business Machines Corp. (IBM):. N.p., 13 May 2013. Web. 15 Aug 2013.  "Benefits of Financing." IBM- Financing with IBM. IBM, n.d. Web. 15 Aug 2013.  Harmer, Martin. "Finance Transformation." IBM- Strategy and Transformation. IBM, n.d. Web. 15 Aug 2013. www.insidermonkey.com/.../international-business-machines-corp-ibm-hedge-funds-and-insiders-are-bearish-what-should-you-do-155060/ Twery, Seth. "Risk Management." IBM. IBM, n.d. Web. 15 Aug 2013. Read More