Foreign Currency Transaction Exposure Faced By Coca Cola & PepsiCo

Transaction Exposure and Its Impact

The dealings which enable the inflow or outflow of a foreign currency lead to a transaction exposure. Foreign Currency Transaction Exposure is the threat faced by the organizations involved in international dealings because of the possibility of the changes in the value of the currency, once the company has entered into the transaction (Antoci, 2015).  The risk of varying conversion rates may lead to the financial losses to the organizations. This answer will focus on the foreign currency transaction exposures faced by Coca Cola and PepsiCo which are multinational beverage corporations and listed on the stock exchanges for more than five years.

The transaction exposure determines the monetary value of the international currency dealings which will have an impact on the organization’s future income declarations (Bresser-Pereira,  Kregel &  Burlamaqui, 2014). The transaction exposure takes into account the book value of assets and liabilities of the organization.  Coca Cola is subjected to risks such as variations in the international conversion rates, commodity prices, credit risk, liquidity risk and risk of fluctuating interest rates (Coca-Cola HBC, 2015). These pose a threat on the company’s economic performance. All these risks are explained below:

1. Variations in the international conversion rates: The Company is facing a huge amount of risk of the variations of the international conversion rates. These risks arise from the variations in the exchange rates of the Euro, US Dollar and the currencies in the Non-Euro countries, as it earns income, incur expenses, hold its properties and pay its financial obligations in the countries using currencies such as Euro, the Japanese yen, the Brazilian real and the Mexican peso. These ascend from the buying of raw constituents in these currencies, resulting in the higher cost of sales to the company. It had US$ 2.7 Billion of foreign exposure loss which was same as its long term borrowed loans .As a result, its annual revenue fell to US$7 Billion. Due to its operations in Venezuela, its annual earnings were affected, resulting in a charge of US$ 247 Million (McGrath, 2015).
2. Risk of fluctuating interest rates: The Company has granted loans, so it is facing the risk of fluctuating interest rates, mainly due to Euros. It also arises because it has invested into highly liquid securities (O’Brien, 2016).
3. Risk of fluctuating commodity prices: The Company is facing the risk of changes in the prices in aluminum, oil, plastics and sugar. These have an impact on the sales because the firm can temporarily assimilate the fluctuations in the prices of the raw materials, thereby passing the extra cost to customers which will reduce its sales ( Poitras, 2013).
4. Credit risk: The Company is facing the risks relating to the insolvency or bad debts. The country’s inability to pay the import price because of the difficulties in Balance of Payments. Moreover, the funds of the buyer may not reach to the seller because of the reasons such as civil war or blockage in the payments for products exported (Capponi, 2013).
5. Liquidity risk: The Company is facing the risk arising out of lack of marketability of the investment which might not be frequently traded in the market; hence it cannot reduce the loss. It occurs when the buyer cannot meet its short term liabilities.

The company is facing market risks such as variations in commodity prices, which affect the cost of raw materials and energy. Also, fluctuations in the international conversion rates and interest rates are also faced by PepsiCo. These are explained below:

1. Variations in commodity prices:  The Company is exposed to fluctuations in the commodity prices because of its limitation in compensating the higher cost in the environment in which transacts.
2. Fluctuations in the international conversion rates:  It is also facing the risk of international currency fluctuations due to its transactions in foreign currency along with creation of propertiesand obligations internationally, in its daily routine. It also involves the compulsion to buy or sell the products or services at former prices and acquiring and granting of funds in international   monetary values (PepsiCo, 2016).
3. Interest rate risks: The Company is suffering from the risk borne by the interest bearing asset such as floating rate loan. If there is an increase in the rate of interest, it has to pay more interest to the other entity.

Hence the  both the companies,  which are competitors face the transaction risk of reduced profits when the cost of raw materials purchased from abroad cannot be remunerated  by the home currency and the decreased sales during inflation in the home country. However, these

risks can be covered by a variety of options such as forward exchange contracts and derivatives (Gyntelberg   & Upper,2013). 

Answer 2.  The tools and techniques used by the companies to face the transaction exposures depend upon the type of risks. The company transacts in certain financial tools to reduce these risks by safeguarding itself from undisclosed monetary threats (Rupeika-Apoga &  Nedovis, 2015). For the companies in which the dealings depend upon the import and export of goods and services, there arises the necessity for hedging. The hedging tools are valid up to 36 months in advance and invalidate within 24 months.

Coca Cola deals with the fluctuations in its foreign transactions in the table mentioned below:

Type of Risk	Tool to minimize the international  transaction risk	Explanation
Fluctuations in the foreign currency	Currency or Forex Hedging          (Coca-Cola HBC ,2015)	It is used to choose an international portfolio. It allows the companies to reduce the risks to any averse exchange rate movements .If used carefully, it can act as an insurance for the company. It can reduce or transform the fluctuations in the foreign currency .The treasury procedures of Coca Cola demands the hedging of rolling of annual estimated transactional exposures within 25 % to 80 % coverages.
Risk of fluctuating interest rates	Interest rate Swap Agreements (PIMCO,2017)	It is a derivative contract through which the entities interchange fiscal instruments. The entities interchange the inflows based on an assumable principal sum. This is done with the intention to protect itself against interest rate risk or to postulate.
Risk of fluctuating commodity prices	Forward  Contracts	It is the contract between two entities in which the vendor agrees to supply to the purchaser a fixed quantum of the commodity at a fixed future date at a price fixed by mutual consent. This contract is executed by mutual consent of both the parties.
Risk of fluctuating commodity prices	Future Contracts	These are identical to Forward contracts .They include additional features such as adjusting the requirements rather than real delivery of goods and services. They are dealt with on systematized exchanges.
Credit and Liquidity Risks	Options	They can be converted into money in the case of unfavorable circumstances. They are two types- Call and Put. The put option fixes a minimum amount for the commodity, which permits the purchaser to take short positions in the futures at a certain amount within a certain time span. The call option permits the highest amount to the purchaser to take long position in the futures at the specific amount in a certain time span.

Techniques used by Pepsi Co to minimize its risks of transaction exposure  

PepsiCo manages its business risks in the following ways:

Type of Risk	Tool to minimize the international  transaction risk	Explanation
Variations in commodity prices	Currency forward contracts	They lock the interchange rate of the future payment of the international monetary value. They are executed when the entity is accountable to pay or obtain the international amount in the future. It safeguards the entity against any devaluation in the currency in which the contract is executed.
Fluctuations in the international conversion rates	Straddle	It is used by those entities, which assume that the amount of the asset will fluctuate remarkably in the future, but uncertain about the position of the moves. They can deal in the combination of options which differ only in the exercise price, known as straddles and strangles.   These are blend of the put and call options to create the conditions independent of the situation of the market movements.
Interest rate risks	Equity Swaps	It is the contract among the entities to interchange amounts assessed by a stock or index, with another amount which is an interest bearing static or fluctuating rate mechanism. They are used as an option for the direct transaction stock.

So, Coca Cola has its transactions in Switzerland, Ireland and Greece in which it has considerably increased its sales. So, if the Euros and Swiss Franc depreciate against US $, then it would be at a threat of foreign currency exposure risks. To mitigate these risks, it uses strategies such as options, swaps, derivates etc. (Coca Cola HBC, 2015). Pepsi Co uses various strategies to safeguard itself from foreign currency transaction exposures. The amounts of the interest rate derivate tools remaining as on 31 December, 2011 and 29 December, 2012 were US$8.3 Billion and US$8.1 Billion. The entity was planning to set off the net losses of US$23 Million, arising out of the accumulated losses from the hedges. About 27 % of the total loans ,was introduced  to fluctuating rate of interests, due to interest rate derivative  tools on 29 December,2012 in comparison to 38 % on 31 December,2011 (Wahlen, Baginski & Bradshaw,2014).

References 

Antoci, V. (2015). Managing transaction exposure in MNCs. Helsinki Metropolia University of Applied Sciences Metropolia Business School European Business Administration. 

Bresser-Pereira,L., C.,  Kregel, J. &  Burlamaqui,L.(2014). Financial Stability and Growth: Perspectives on Financial Regulation and New Developmentalism. Routledge.

Capponi,A. (2013).Pricing and Mitigation of Counterparty Credit Exposures . Handbook of Systemic Risk. Cambridge University Press.

Coca Cola HBC (2015).Refreshing business. [ONLINE]  Available at https://coca-colahellenic.com/media/2390/coca-cola-hbc_2015-integrated-annual-report.pdf [Accessed on:  5^th January, 2018].

Coca Cola HBC(2016).Debt investors. [ONLINE]  Available at https://coca-colahellenic.com/en/investors/debt-investors/financing-strategy/[Accessed on:  5^th January,2018].

Coca-Cola HBC (2015). Risk Management. Business Resilience: Managing our risks and opportunities. [ONLINE]  Available at https://coca-colahellenic.com/media/2596/business-resilience.pdf [Accessed on:  5^th January,2018].

Gyntelberg,J. & Upper,C.(2013). The OTC interest rate derivatives market in 2013. BIS Quarterly Review.

McGrath, M. (2015).Currency Swings Take The Air Out Of Coca-Cola Fourth Quarter Profit. ‘Forbes’ [ONLINE] Available at https://www.forbes.com/sites/maggiemcgrath/2015/02/10/foreign-exchange-takes-the-air-out-of-coca-cola-fourth-quarter-profit  [Accessed on:  5^th January,2018].

 O’Brien,T.,J(2016) Houston Marine Electronics. International Finance Case on FX Transaction Exposure.

PepsiCo (2016). Annual Report . [Online].Available at https://www.pepsico.com/docs/album/annual-reports/pepsico-inc-2016-annual-report.pdf. [Accessed on : 3 January ,2018]

PIMCO(2017) Understanding Investing :Interest Rate Swaps. [ONLINE]  Available at https://global.pimco.com/handlers/displaydocument.ashx?wd=Information%20Memorandum&fn=45177%20Understanding%20Interest%20Rate%20Swaps.pdf&id=fhvUot0TiX9g1hOowS%2BhrYou25PJETkENVMXRKEZSAtgspFvXgSK1mKwrxmuYlZ7xz10oaAxoz%2FkyU%2FgmVm9aghrKoHp3kWzQHzBgFhA4h4O8uTc4P0SfpAY8rDAjtnxEr2gpLYEQ2YoVEyAR9vcDmm6dqQ2FRh%2Fql%2FDmLoJTJwjOxH0x2yN%2BjYB%2B4ZYWxBixQAFkc15s54eLAJk5uPB7A9n65KgHOZlqjpwFVdG2sLyoH3y2nHON6JRcgKjZEX7TMFn10gPx8qER0f%2FE%2FrHYXY2pYL8i2ZfAWCFsUTXBf%2FAIgMDaBHbXaZie3SdYG62 [Accessed on:  5^th January, 2018].

Poitras,G.(2013).Commodity Risk Management: Theory and Application. Routledge.

Rupeika-Apoga ,R. & Nedovis,R.(2015) The Foreign Exchange Exposure of Non-Financial Companies in Eurozone: Myth or Reality? International Journal in Economics and Business Administration.3(1).

Wahlen, J. M. , Baginski , S.P. & Bradshaw, M. (2014). Financial Reporting, Financial Statement Analysis and Valuation. Cengage Learning.