Foreign Exchange Risk Management for A Global Engineering & Construction Company

As a leading engineering, procurement and construction (EPC) firm in Taiwan, CTCI Corporation has recently expanded its reach to global market. Along with the increasing overseas revenue, foreign exchange risk management turns into a critical issue for its operation. There are considerable researches published on the topic of foreign exchange risk management, exchange rate forecast, financial tools for risk management and so forth. However, it's not readily available for those specifically for EPC industry. EPC industry is unique in terms of business operation, and foreign exchange management needs to be implemented from the beginning stage of bidding. During project execution, the creditability and maintenance of cash flow system are key success factors of a sound foreign exchange risk management. To understand the risk exposure, this research is focused on the operations and business pattern of the EPC firm and thus, uses it as a particular case for study. A series of analysis to the historical data were carried out during the process.
The marginal profit out of its revenue has been fragile against the impact of exchange risk. Demand of foreign exchange is of less credibility due to incapable system, improper budget planning and uncertain procurement and therefore, increases risk exposure. To minimize the net aggregated foreign exchange or to confirm procurement earlier will be helpful on reducing the risk. In addition, this research identifies the current IT system of the company is no longer satisfying the requirements of the sophisticated function of a global company. Therefore, to equip the operations with state-of-the-art ERP system shall be of higher priority on resolving cash flow issues. Through survey, the researcher understood another risk of lacking hedging strategy and operational standard of foreign exchange risk management. In the thesis, two hedging instruments, "Forward" and "SWAP" are recommended for risk management in consideration of their simplicity and easiness for control. In analysis of the suitable portion (percentage) of net foreign exchange to be hedged, the research also addressed that 100% and zero hedging strategies are not the real solutions to foreign exchange risk issues as the profit or loss could be the highest among all, which is not preferable in terms of risk management and valuation of financial assets for hedging.
To have effective risk avoidance, a dynamic hedging model is proposed. The model is based on the concept of limiting the risk to a certain level, which is acceptable to the company. To make sure the model is workable, an operation model was designed and the actual exercise using the historical data was conducted. The result seems satisfactory. Therefore, it's believed that, through further study and rectification, the model may be applicable to the foreign exchange risk management potentially in the future.