Foreign exchange risk

[Tang Huynh Yen Phuong] 2011

UNIVERSITY OF ECONOMICS HO CHI MINH CITY
FACULTY OF COMMERCE– TOURISM- MARKETING

GRADUATE THESIS

Topic
“EVALUATING TRANSACTION EXPOSURES AND HEDGING
SOLUTIONS FOR IMPORTING STEEL AT CONSTRUCTION
AND MATERIALS TRADING JOINT STOCK COMPANY.”

ADVISOR: NGUYEN KIM THAO, MBA.

STUDENT: TANG HUYNH YEN PHUONG

CLASS: FT1 - COURSE: 33

2007-2011
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Evaluating transaction exposures and hedging solutions for importing steel
at Construction and materials trading joint stock company

Tang Huynh Yen Phuong

University of Economics of Ho Chi Minh City

Foreign Trade 1

Nguyen Kim Thao, MBA

May 22rd ,2011

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ACKNOWLEDGEMENT

This paper could not have been completed without the help,
encouragement, and support from a number of people who all deserve
my sincerest gratitude and appreciation.
First and foremost, I would like to express my deepest and sincere
gratitude to my thesis advisor, Professor Nguyen Kim Thao, MBA., for
her invaluable comments, and for her expert and constant guidance, and
for her encouragement, patience, and support during the entire process of
this thesis.
I am grateful to Professor Nguyen Thi Hong Thu, MBA., for helping me
on my thesis. Without her direction and advice, this thesis could not have
been completed.
I would also like to sincerely thank to the Vice General Director of
Construction and Materials Trading Company, Mr Phung Dat Duc, and
the Manager of Sales Department No. 2, Mr Tran Chi Hieu for giving me
permission to commence this thesis in the first instance, and to do the
necessary research work and to use departmental resources.
Special words of thank also go to the members of Sales Department No.
2, Mr. Nguyen Hoang Duy, and Ms. Le Bao Thao Nguyen, for their
support, and guidance during my time of internship.
Finally, my deepest gratitude and appreciation go to my family. Their
love, support and constant encouragement gave me a great deal of
strength and determination that helped me during the stressful time of
writing this paper.
Ho Chi Minh City, May 2011

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COMMENTS OF THE COMPANY

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COMMENTS OF THE ADVISOR

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ABSTRACT

“EVALUATING TRANSACTION EXPOSURES AND HEDGING SOLUTIONS
FOR IMPORTING STEEL AT CONSTRUCTION AND MATERIALS TRADING
JOINT STOCK COMPANY.”

By

University of Economics Ho Chi Minh City

Professor Nguyen Kim Thao, MBA., Thesis Advisor

The international trade allows goods ,and services to travel across countries ,as well
as the currency. Construction and Materials Trading Company (CNT) has major
business activities internationally and domestically. Therefore, it is an enduring task
for the company in dealing with the effects of exchange rate volatility on the cost of
imports. Over the past few years, CNT has been using the price decisions hedging
strategy in handling its transaction exposures. However, this hedging tool began to
show some drawbacks because it could not reduce transaction risks, especially
during the period of global economic crisis. Therefore, the research would like to
evaluate the transaction exposure in import activities at CNT. It also studies other
available hedging tools to offer some alternative choices for CNT‟s hedging
strategies in managing their transaction exposure.

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TABLE OF CONTENTS

CHAPTER 1- LITERATURE REVIEW ......................................................... 4
1.1. IMPORT.................................................................................................................. 4
1.1.1. Definition of importing ..................................................................................4
1.1.2. The benefits and drawbacks of importing .....................................................5
1.2. FOREIGN EXCHANGE MARKET .......................................................................... 5
1.3. EXCHANGE RATE DETERMINANTS ................................................................... 5
1.3.1. Purchasing Power Parity (PPP) .....................................................................6
1.3.1.1. Absolute Purchasing Power Parity.........................................................6
1.3.1.2. Relative Purchasing Power Parity ..........................................................6
1.3.2. Interest Rate Parity theory (IRP) ...................................................................6
1.4. FOREIGN EXCHANGE RISK AND FOREIGN EXCHANGE EXPOSURES ............. 7
1.4.1. Foreign exchange risk ....................................................................................7
1.4.2. Foreign exchange exposure ...........................................................................7
1.5. TRANSACTION EXPOSURES AND MANAGING TRANSACTION EXPOSURES 9
1.5.1. Transaction exposure .....................................................................................9
1.5.2. Managing transaction exposures....................................................................10
1.5.2.1. Identify the degree of exposures ............................................................10
1.5.2.2. Make decision on hedging the exposures ..............................................10
1.5.2.3. Choose a hedging technique ..................................................................10
1.5.2.3.1. Hedging techniques ..........................................................................11
1.5.2.3.2. Operational techniques .....................................................................15
1.6. OVERVIEW OF VIETNAM FOREIGN EXCHANGE MARKET .............................. 16
1.6.1. Background of Vietnam‟s exchange rate regime...........................................16
1.6.2. Vietnam‟s exchange rate regime during 1994-2011 periods .........................17
1.6.3. Mechanisms to support stability of the VND/USD rate ................................18
1.6.3.1. Official exchange rate ............................................................................18
1.6.3.2. Allowable trading band ..........................................................................21
1.6.3.3. Official intervention ...............................................................................21
1.7. OVERVIEW OF VIETNAM‟S DERIVATIVES MARKET ....................................... 22
1.7.1. Forward transaction .......................................................................................23
1.7.2. Currency options ............................................................................................26
1.7.3. Swap ..............................................................................................................28
1.7.4. Evaluation ......................................................................................................29

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CHAPTER 2- RISK ANALYSIS OF TRANSACTION EXPOSURE .......... 31
2.1. PROFILE OF CNT................................................................................................... 31
2.1.1. Introduction....................................................................................................31
2.1.2. Establishment and history ..............................................................................32
2.1.3. Vision and mission ........................................................................................33
2.1.4. Scope of Business ..........................................................................................33
2.1.4.1. Construction ...........................................................................................33
2.1.4.2. Investment ..............................................................................................33
2.1.4.3. Industrial and construction material production ....................................34
2.1.4.4. Import - export trade ..............................................................................34
2.1.4.5. Local product trade ................................................................................34
2.1.5. Organizational structure.................................................................................35
2.1.5.1. General Shareholder‟s Meeting .............................................................36
2.1.5.2. Board of management ............................................................................36
2.1.5.3. Board of supervisors ..............................................................................36
2.1.5.4. Board of directors...................................................................................36
2.1.5.5. Functional departments ..........................................................................36
2.1.6. Human resources ...........................................................................................37
2.1.7. Business performance ....................................................................................37
2.1.7.1. Profit structure........................................................................................37
2.1.7.2. The situation of import activity..............................................................41
2.1.7.2.1. Import-turnover ..............................................................................41
2.1.7.2.2. Distribution of imports by commodity ...........................................42
2.1.7.2.3. Distribution of imports by country of origin ..................................43
2.1.8. Evaluate the position of CNT ........................................................................45
2.2. RISK ANALYSIS OF TRANSACTION EXPOSURES AT CNT ............................... 46
2.2.1. Overview of Steel import activities ...............................................................46
2.2.2. Analyze the procedure of Steel trade. ............................................................50
2.2.3. Transaction exposures from 2006-2010 ........................................................55
2.2.5. Current Risk management strategies at CNT and evaluation ........................66
CHAPTER 3- HEDGING STRATEGY .......................................................... 75
3.1. AVAILABLE HEDGING TOOLS FOR CNT COMPANY AND EVALUATION ....... 75
3.1.1. Lead strategy ..................................................................................................76
3.1.2. Credit loans denominated in Vietnam dong ..................................................78
3.1.3. Hedging techniques .......................................................................................79
3.1.3.1. Forward ..................................................................................................80
3.1.3.2. Option.....................................................................................................83
3.1.4. Risk sharing ...................................................................................................84
3.2. DESIGN HEDGING STRATEGY FOR THE COMPANY ......................................... 87

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3.3. RECOMMENDATION FOR STATE BANK OF VIETNAM ....................................... 90

CONCLUSION .................................................................................................. 93
APPENDIX ......................................................................................................... 95
REFERENCE ..................................................................................................... 118

LIST OF APPENDIXS

Appendix 1-Balance Sheet 2009
Appendix 2-Income Statement 2009
Appendix 3- Balance Sheet 2010
Appendix 4- Income Statement 2010
Appendix 5- Forward Contract at Eximbank
Appendix 6- Option Contract at Eximbank
Appendix 7- Contract Exercise Request
Appendix 8- Agreement On Currency Options
Appendix 9- Revenue Structure 2008-2010
Appendix 10- Costs Of Goods Sold 2008-2010
Appendix 11- Gross Profit Structure 2008-2010
Appendix 12- Income Statement 2006-2010
Appendix 13- Main Financial Indicators Of CNT 2006-2010
Appendix 14- Transaction Exposures Of Steel Import Activities In 2006-2010
Appendix 15-The Effects Of Transaction Exposure After Hedging On The Profit Margin
Of Some Import Contract In 2006-2010
Appendix 16 -Steel import proposal of Phu My Steel Company.

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LIST OF TABLES
Table 1.1- Comparison of translation, transaction and operating exposure ...................09
Table 1.2- Changes of average inter-bank exchange rates and allowable trading bands
during 2008-2011 period..............................................................................18
Table 1.3- Changes of average inter-bank exchange rates during 2007-2011 period. ...19
Table 1.5- Option transaction premium of Eximbank in March 2011............................27
Table 1.4- Spot rate and forward rate of Eximbank on March 2011 ..............................25
Table 2.1- List of shareholders holding over 5% as of May 14, 2010............................31
Table 2.2-Staffs and employees (2010) ..........................................................................37
Table 2.3- Profit structure of CNT during 2006-2010 ....................................................38
Table 2.4- Import-turnover 2008-2010 ...........................................................................41
Table 2.5- Distribution of imports by commodity ..........................................................42
Table 2.6- Distribution of imports by country of origin .................................................43
Table 2.7- The situation of signing and implementing Steel import contract ................46
Table 2.8- Steel import proposal of CNT company........................................................52
Table 2.9 -Transaction exposures of some Steel Beam contracts during 2006-2010 .....56
Table 2.10 -Transaction exposures of some Steel Beam contracts during 2006-2007 ...57
Table 2.11- Transaction exposures of some Steel Beam contracts in 2008 ...................60
Table 2.14- Import proposal of CNT with price decision hedging tool. ........................67
Table 2.16- The actual transaction exposure after hedging in 2006-2007. .....................69
Table 2.17- The actual transaction exposure after hedging in 2008-2009. .....................71
Table 2.18- The actual transaction exposure after hedging in 2010. ..............................73

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LIST OF FIGURES
Figure 1.1- Types of Foreign Exchange Exposure ............................................................ 8
Figure 1.2- Hedging techniques to manage transaction exposure ..................................... 11
Figure 1.3- Allowable Variations around Official Exchange Rate Mar 1989 - Mar 2011 . 21
Figure 2.1-Establishment and history of CNT .................................................................... 32
Figure 2.2- Organizational structure ................................................................................... 35
Figure 2.3- Staffs and employees ....................................................................................... 37
Figure 2.4- Profit structure of CNT during 2006-2010 Chart............................................. 39
Figure 2.5- The procedure of Steel Beams trade. ............................................................... 50
Figure 2.6- Price decidion hedging tool .............................................................................. 66
Figure 3.1- Available hedging tools for CNT ..................................................................... 75
Figure 3.2- Lead strategy to hedge transaction risk ............................................................ 76
Figure 3.3- Credit loans denominated in Vietnam dong ..................................................... 78
Figure 3.4- Financial instruments ....................................................................................... 79
Figure 3.5- Forward transaction procedures ....................................................................... 81
Figure 3.6- Risk sharing hedging tool ................................................................................ 84

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PREFACE

In the nature of international trade, many companies are exposed to the risk of
exchange rate fluctuation. The purchases from international suppliers in other
countries, and sales to domestic buyers with account payables and account
receivables in different currencies will give rise to foreign exchange risks.
1. General problem statement
In an effort to meet the demand of the Vietnamese building materials market,
Construction and Materials Trading Company is involved greatly in the
international trade. Profit from materials trading makes up approximately 75 percent
of CNT‟s total profit. In CNT company, the imports of Steel such as Steel Beams,
Steel Plate, Steel Sheet... often create account payables in foreign currency (US
dollar) with the suppliers. The sales of these commodities often create account
receivables in home currency (VND) with domestic buyers. Therefore, the company
suffers from transaction risks during its steel trading process from the beginning of
the purchase made until the payment is settled.
According to CNT‟s management, the transaction exposure loss rarely happens, and
is considered insignificant because the State Bank of Vietnam uses many
mechanisms to support stability of the VND/USD exchange rate. Therefore, there
were only minor transactions, which were hedged in the past. The hedging strategy
used is only limited with the price decisions tool. However, it is a necessary task for
the company to design a flexible hedging strategy with different hedging tools. A
proper hedging strategy can help the company to deal with the risk of exchange rate
volatility in different stages of the economic cycle. Thus, the research would like to
analyze other currency hedging tools which are possible to implement at CNT
company, and design a suitable hedging strategy for the company for the long-term.
There are two aspects of the research problem:
1. The influences of Vietnam dong fluctuation against US dollar to the accounts
payable of CNT over the last five years.

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2. Determine which hedging tools are available for the company, and design a
suitable hedging strategy for the company for the long-term.
2. Research objectives
A company is subject to transaction exposure whenever there are receivables or
payables in foreign currency denominations. The hedging concept in managing
transaction exposure is to be able to reduce the risk from currency fluctuations. In
the end, the research will be performed as an input for further improvement at CNT.
According to that, the research objectives of this thesis are:
1. Acknowledgement of how CNT handle transaction exposure derived from
the foreign exchange rate fluctuations of Vietnam dong against US dollar
currency.
2. Study the hedging strategies available which CNT may possibly implement
to reduce risks from the exchange rate fluctuations.
3. Provide alternative choices for CNT hedging strategies in managing
transaction exposures.
3. Scope of the thesis
The thesis aims to identify the effect of foreign exchange fluctuation on the profit of
some Steel import contracts of Construction and Material Trading company.
The timeframe of the study is limited to the last five years, starting with year 2006
and ending with year 2010, depending on the availability, and reliability of the data.
In this thesis, the author only has allowance to show certain parts of information
that was given by the company because it is confidential. The data are collected
from the Import- Export sales department No.2 of CNT company, and focuses on
Steel import contracts and relevant documents.
The foreign exchange rate used in this thesis is the rate offered by Vietcombank, not
the foreign exchange rate in the black market. It is assumed that the company can
approach the US Dollar source at banks.

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4. Methodology
The methodology used to accomplish the objective, is by doing a literature study,
collecting primary and secondary data, processing the data, performing inductive
and explanatory research, and analyzing the result.
Literature study- to deepen knowledge about foreign exchange risk, and the
overview of the Vietnamese foreign exchange market.
Collecting data- From the reported data provided by the company, specialized
reference books, information from newspapers, magazines, internet, and some
research related to the topic.
Processing the data- through these methods.
- Statistics by tables, charts, formula: statistics to find out common
characteristics of analyzed factors.
- Comparison methods: compare the same kind of numbers to find the
increasing and decreasing in each year.
- Methods of Experts: consult the experts.
5. The organization of the thesis
The thesis would be divided into three chapters which consist of:
CHAPTER 1: LITERATURE REVIEW

This chapter explains theories behind the analysis done in this thesis, the overview
of the foreign exchange market, and the derivatives market in Vietnam.

CHAPTER 2: RISK ANALYSIS OF TRANSACTION EXPOSURE

This chapter gives a brief overview regarding the company, detailed analysis of the
transaction exposure in the last five years as well as the current hedging tool of the
company.

CHAPTER 3 DESIGNING HEDGING STRATEGY

This chapter includes some available hedging tools, and long-term hedging strategy
for the company and recommendations for the State Bank of Vietnam to manage the
derivatives market.

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CHAPTER 1- LITERATURE REVIEW

1.1. Import
1.1.1. Definition of importing
Importing is the purchasing side of trade and takes place when one region acquires
goods or services from another region. Importing is linked with international trade
and generally is distinguished from trade within a specific nation because importing
involves government regulation. (Importing, n.d.)
1.1.2. The benefits and drawbacks of importing
a. Benefits

Many economists, businesses, and politicians continue to rely on the principle of
comparative advantage and it still influences import theories and policies.
Consequently, countries continue to import products because they can obtain them
less expensively abroad.
In addition, given the technology, labor costs, government incentives, and subsidies
of different countries, one country may be able to produce goods more efficiently
than other countries. Hence, other countries will seek to import these goods because
of price and perhaps quality advantages. For example, other countries import
Robusta Coffee from Vietnam, while Vietnam imports Machinery from other
countries such as Japan and China.
Importing allows countries to achieve higher standards of living by obtaining
products and resources that cannot be obtained domestically. For example, in order
for the Vietnam to maintain its standard of living, it must import petrol, since the
country cannot produce a sufficient amount to satisfy consumer demand.
b.Drawbacks

Many economists and governments believe that importing goods can lead to the
erosion of their national economies- especially when imports exceed exports.
Importing goods poses other problems such as the tacit acceptance of social values
that conflict with domestic values. Importing goods from countries that pay low

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wages, for instance, can cripple domestic industries that cannot compete because
they have a minimum wage, obligations to labor unions, and so forth.
Furthermore, importing cheap goods, especially textiles, from countries that force
employees- even children- to work in sweatshop conditions overlooks the type of
treatment of employees that many countries condemn.
1.2. Foreign exchange market
An exchange rate is a price of one currency against another currency. The foreign
exchange market is a market in which national currencies are bought and sold
against one another. The foreign exchange market is an over the counter market
because the market players are located in the major commercial banks around the
world. The foreign exchange market comprises transactions among four groups of
participants: dealers, brokers, cuctomers and central banks (Morris Goldstein,
1993).
Two fundamental types of the exchange rates (Gaurav Akrani. 2010) :
Spot exchange rate : This refers to the price of foreign exchange in terms of
domestic money payable for the immediate delivery of particular foreign
currency. It is an existing or day-to-day exchange rate.
Forward exchange rate : There are several future transactions whose delivery
would be made sometime in the future. The rates at which these transactions
are consummated are called as forward rate of exchange. It is the rate
fulfilling the agreement between two parties based on future delivery of
goods.
1.3. Exchange rate determinants
The exchange rate, just like commodities, determines its price responding to the
forces of supply and demand. Therefore, if for some reason people increase their
demand for a specific currency, then the price will rise, provided the supply remains
stable and vice versa.
Some of the factors that influence currency supply and demand are inflation rates,
interest rates, economic growth, and political and economic risks.

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Furthermore, international parity conditions describe the core financial theories
surrounding the determination of exchange rates. This economic theory links
exchange rates, price levels and interest rates together. The international parity
conditions encompassed:
1.3.1. Purchasing Power Parity (PPP)
1.3.1.1. Absolute Purchasing Power Parity
In it absolute version, purchasing power parity states that price levels should be
equal worldwide when expressed in a common currency. However, absolute
Purchasing Power Parity ignores the effects on free trade of transportation costs,
tariffs, quotas and other restrictions and product differentiation (Alan C.Shapiro,
2009) .
1.3.1.2. Relative Purchasing Power Parity
The relative version of Purchasing Power Parity states that the exchange rate
between the home currency and any foreign currency will adjust to reflect changes
in the price levels of the two countries. (Alan C.Shapiro, 2009) .
Formally, if ih and if are the rates of inflation for the home country and the foreign
country, respectively; e0 is the home currency value of one unit of foreign currency
at the beginning of the period; and e1 is the spot exchange rate in period 1, then

=

1.3.2. Interest Rate Parity theory (IRP)
According to interest rate parity theory, the currency if the country with a lower
interest rate should be at a forward premium in terms of the currency of the country
with the higher rate. More specifically, in an efficient market with no transaction
cost, the interest differential should be (approximately) equal to the forward
differential. Interest rate parity holds when there are no covered interest arbitrage
opportunities. According to Alan C.Shapiro, (2009) this no-arbitrage condition can
be stated as follows:

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=

rh: represents the nominal rate of home currency
rf: represents the nominal rate of foreign currency
f1:the forward rate at time 0 for delivery of one unit of foreign currency at time 1.
1.4. Foreign exchange risk and foreign exchange exposures
1.4.1. Foreign exchange risk
Maurice D. Levi defined foreign exchange risk as “the variance of the domestic
currency value of assets, liabilities, or operating incomes that is attributable to
unanticipated changes in foreign exchange rates.” By definition, foreign exchange
risk depends on the exposure, as well as the variability of the unanticipated changes
in the relevant exchange rate. “Foreign exchange risk is related to the variability of
domestic currency values of assets or liabilities due to unanticipated changes in
exchange rate.” (Maurice D. Levi, 2008, as cited in Thummuluri Siddaiah, 2009,
pp.127)
1.4.2. Foreign exchange exposure
Maurice D. Levi also define the meaning of foreign exchange exposure. “It is
shown that exposure is a measure of the sensitivity of changes in domestic currency
values of assets, liabilities or operating incomes to unanticipated changes in
exchange rates” (Maurice D. Levi, 2009, pp. 283)

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Figure 1.1- Types of Foreign Exchange Exposure

Foreign Exchange Exposure

Economic exposure Translation exposure

Transaction
exposure

Operating
exposure

Alan C.Shapiro (2005) cateforized foreign exchange exposure into economic
exposure and translation exposure (see Figure 1.1).
Economic exposure refers to potential changes in all future cash flows of a
firm that result from unanticipated changes in exchange rates. Economic
exposure may further be classified into transaction exposure and operating
exposure. Transaction exposure refers to potential changes in the value of
contractual future cash flows, or monetary assets and liabilites, resulting
from changes in the exchange rate. Opreating exposure, on the other hand,
represents the potential changes in the value of nonmonetary or real assests
and liabilites due to unanticipated changes in exchange rates.
Translation exposure is also knowns as accounting exposure. It arises when
items of financial statements that are stated in foreign currencies are restated
in the home currency of an multinational corporation.

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Table 1.1- Comparison of translation, transaction and operating exposure
Comparison of translation, transaction and operating exposure
Translation Exposure Operating Exposure
Changes in income statement items and Changes in the amount of future
the book value of balance sheet assets operating cash flows caused by an
and liabilities that are caused by an exchange gains or losses are determined
exchange rate change. The resulting by changes in the firm‟s future
exchange gains and losses are competitive position and are real. The
determined by accounting rules and are measurement of operating exposure is
paper only. The measurement of prospective in nature as it is based on
accounting exposure is retrospective in future activities.
nature as it is based on activities that
occurred in the past
Impact: Balance sheet assets and Impact: Revenues and costs associated
liabilities and income statement items with future sales.
that already exist.

Exchange rate change occurs
Impacts: Contracts already enterd into, but... to be settled at a later date.
Transaction exposure
Changes in the value of outstanding foreign-currency-denominated contracts (i.e,
contracts that give rise to the future foreign currency cash flows) that are brought
about by an exchange rate change. The resulting exchange gains and losses are
determined by the nature of the contracts already entered into and are real. The
measurement of transaction exposure mixes the retropective and propextive because
it is based on activities that occurres in the past but will be settles in the future.
Contracts already on the balance sheet are part of accounting exposure, whereas
contracts not yet on the balance sheet are part of operating exposure.
Source: Alan C.Shapiro (5th). (2005) Foundations of multinational financial
management (pp,252)
1.5. Transaction exposures and managing transaction exposures
1.5.1. Transaction exposure
According to Thummuluri Siddaiah (2009), transaction exposure refers to potential
changes in the value of contractual cash flows that arise due to unexpected changes
in the foreign exchange rate. It is a measure of the sensitivity of the home currency

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value of assets and liabilities in foreign currency to unanticipated changes in
exchange rates. According to Henri L. Beenhakker (2002), transaction exposure
arises from:
Borrowing or lending funds when repayment is to be made in a foreign
currency.
Purchasing or selling on credit goods or services whose prices are stated in
foreign currencies.
Being a party to an unperformed foreign exchange forward contract.
Acquiring assets or incurring liabilities denominated in foreign currencies.
1.5.2. Managing transaction exposures
1.5.2.1. Identify the degree of exposures
After identified the types of risk which a company is exposed to, the next crucial
step in a company‟s risk management decision is the risk measurement. According
to South/Western Thomson Learning (2003), to measure the transaction exposure a
company should project the net amount of inflows and outflows in each foreign
currency and determine the overall risk of exposures to those currencies.
(South/Western Thomson Learning, 2003, as cited in Yasmin Nur Annisa , 2008,
p27) .
1.5.2.2. Make decision on hedging the exposures
The decision whether to hedge or not required a depth analysis. The company needs
to consider to what extend a company are willing to take the risk, whether the
company has the risk adverse attitude or not. The gains and losses shouls be
compared with the existing exposure and the predetermined exchange rate budget,
which has been agreed by the management. The company‟s level of certainty
whether a specific event will occur or not also determine the risk management
decision. A company can decide to do notthing or to hedge its exposure. (Yasmin
Nur Annisa , 2008, p28)
1.5.2.3. Choose a hedging technique

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According to Alan C.Shapiro (2005), there are many techniques by which the firms
can manage their transaction exposure. These techniques can be broadly divided in
to hedging techniques and operational techniques. Hedging refers to taking an
offsetting position in order to lock in the home currency value for the currency
ecposure, eliminating the risk arising from changes in the exchange rate. The
important hedging techniques are forwards/futures, money market hedges, options
and swaps. Operational techniques include exposure netting, leading and lagging
and currency of invoicing.
Figure 1.2- Hedging techniques to manage transaction exposure

Managing transaction exposure

Hedging Operational
techniques techniques

Forwards and Money Netting and
future market hedge offsetting

Currency of
Swaps Options invoicing

Leading and
lagging

1.5.2.3.1. Hedging techniques
* The Derivatives Market is meant as the market where exchange of derivatives
takes place. Derivatives are one type of securities whose price is derived from the
underlying assets. And value of these derivatives is determined by the fluctuations
in the underlying assets. These underlying assets are most commonly stocks, bonds,
currencies, interest rates, commodities and market indices. The Derivatives can be
classified as Future Contracts, Forward Contracts, Options, Swaps and Credit
Derivatives. (Meaning Derivatives Market, n.d.).
(i) Forward

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The forward market involves contracting today for the future purchase or sale of
foreign exchange. Forward contact is a legally binding agreement between two
parties calling for the sale of an asset or product in the future at a price agreed upon
today. The forward contract cannot be traded in the stock exchange but they are
traded among financial institutions or between financial institutions and its clients.
Forward contract is tailor made on its currency rate, delivery date and the amount
involved which is negotiated by the party involved in the contract. The forward
contract value is equal zero but the future rate is changing and the delivery price is
fixed. Therefore, there is a possibility for gain or losses realized on the settlement
date from the exchange rate fluctuation.
Forward contacts are the most common means of hedging transactions in foreign
currencies because of its simplicity. The trouble with forward contracts, however, is
that they require future performance, and sometines one party is unable to perform
on the contract. When that happens, the hedges disappears, sometimes at great cost
to the hedger.
(ii) Futures
In contrast to forward contract, a futures contract has standardized features on its
contract size, delivery date, daily resettlement and so forth. Futures are exchange
trade which means traded on organized exchanges rather than over the counter. A
client desiring a position in futures contracts contacts his broker, who transmits the
order to the exchange floor where it is transferred to the trading floor. In the trading
floor, the price for order is negotiated by open outery between floor brokers or
traders.
Futures recognized the gain and losses daily because its daily resettlement features.
Frequently, a futures exchange may have a daily price limit on the futures price, that
is, a limit as to how much the settlement price can increase or decrease form the
previous day‟s settlement price.
Nevertheless, futures only allow companies to hedge approximately because
futures‟ strandardized instruments on its contract size, delivery date and so forth. In

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addition, due to marking to market property, there are interim cash flows prior to
the maturity date of the futures contract that may have to be invested at uncertain
interest rates. As a result, exact hedging would be be difficult.
(iii) Option
An option contract is a type of contract agreement which give the owner the right,
but not the obligation, to sell or buy underlying asset in a predetermined price
during a certain period of time in the future. A person who buys an option contract
pays a premium to the option‟s seller to compensate the ability of setting the floor
or ceiling price decision. The option holder has the right not to exercise the contract
it the market price moves outside the projected rate.
There are two types of options, American and European. American option can be
exercised anytime during the contract validity. European option only can be
exercised at the maturity date. Option does not have standardized features and made
according to the company‟s specific needs. Option also differentiated as:
Call Option, which is an option to buy an underlying asset. A company
exercises the call option if the spot rate is in the money position, in this case
when the spot rate is bigger than the exercise price.
Put Option, which is an option to sell an underlying asset. A company
exercises the put option if the exercise price is bigger than the spot rate.
In hedging using options, options with its premium is considered more expensive
because of its flexibility in the tailor made value. Options are particularly suited as a
hedging tool for contingent cashflow, for example in bidding processes.
(iv) Hedging with swap contracts
A swap is an agreement between two parties to exchange a cash flow in one
currency against a cash flow in another currency according to predetermined terms
and conditions, to put it differently, a swap agreement requires periodic payments
from one party to the other party in order to safeguard against unfavourable
exchange rate movements. A firm which expects certain cash flows in a foreign
currency in the future may enter into a swap contract in order to hedge those cash

25


flows against foreign exchange rate fluctuation. Currency swap are generally used
to hedge long-term transaction exposures.
(v) Money market
Money market strategy for hedging involved the investing and borrowing in the
currency market. The company can invest in the loan in the short term investment
such as buying securities or deposit in a bank. For example, a company hedges a
receivable by locking in the value of a foreign currency transaction in the home
currency and hedges a payable by locking in the value of a foreign currency
transaction in the foreign currency. The implementation of money market hedge for
payables is explained as below steps:
Define how much is the liabilities‟size at the due rate.
Define the present value of the payables with the foreign currency deposit
interst rate, and then covert it to the home currency.
Loan the money in the home currency, covert it in the foreign currency, and
invest in the foreign currency deposit. At the due date, the deposit will cover
the exact amount of the payables in the foreign currency.
The cash outflow at the due date is exactly the same amount as the loan plus
interest rate a company had. Therefore, the company can avoid the loss
possibility for the exchange rate fluctuation if the home currency depreciated
against the foreign currency.
The most attractive feature from money market hedge is its liquidity. A company
can easily turn the funds into cash, for instance with writing a check. Money market
is probably one of the safest places for saving the capital. The funds are invested in
relatively secure government or other short-term, high-quality debt.
However, a company has an opportunity cost by using the money market hedge.
The funds invested in a money market account could have fared better in a different
investment instruments such as a stock or a bond. Moreover, money market can
sometimes fail to keep pace with inflation which means an investor‟s purchasing

26


power may decline each year. Thus, money market is not suitable for an extended
period of time.
1.5.2.3.2. Operational techniques
(i) Invoice currency
A company can hedge through the choice of invoice currency. The exchange rate
can be shifted to another party by invoicing another party using the company‟s
home currency. Moreover, a company can share the risk by invoicing another party
by half in another party‟s currency and half in the company‟s domestic currency. A
company can diversify the exchange rate exposure through basket of currencies as
the invoice currency. Invoicing in currency baskets can be a useful hedging tool
when no forward or currency contracts are available. However, a company should
also consider the customer‟s convenient level. The customers may choose another
company which has simplier payment method.
The important factors that govern invoicing are historic relationships between the
trading partners and the relative bargaining powers of partners. Sometimes, neither
of the parties involved may have any choice, as in the case of crude oil exports,
which are conventionally invoiced in the U.S dollar.
(ii) Lead/ Lag Strategy
The strategy involve adjusting timing of foreign currency receipts and payables and
to take advantage of an expected currency depreciation or appreciation. Lead means
to pay or collect early and lag means to pay or collect late. If a currency
appreciating, a company should pay the bills in that currency early and let customer
pay late as long as they pay in that appreciation currency. It a currency depreciating,
a company should give incentives to customers to pay early and the company
should pay the payables late. If the paying or receiving currency are equally weak or
strong, ther is no advantage in leading or lagging from a currency exposure
viewpoint.
A good relationship between suppliers and customers is required for implementing
the strategy, as to be willing to grant extra credit period or negotiating discount for

27


prompt payment. Thus, lead and lag strategy commonly applied to intercompany
transaction as there would be minimal conflict between suppliers and customers.
(iii) Exposure netting
A firm may have a transaction exposure portfolio with exposures in different
currencies. When exchange rates change, there may be gains on some currencies
and losses on others. Exposure netting is a portfolio approach to hedging, according
to which a firm may manage its trade transactions in such a way that exposures in
one currency will be offset by exposures in the same or other currencies. This,
infact, provides a natural hedge. A firm can have more stable cash flows if it has
currency diversification, which can limit the potential impat of changes in any
single currency on the cash flows of a firm.
(iv) Price decisions
The general rule on credit sales overseas is to convert between the foreign currency
price and the dollar price by using the forward rate, not the spot rate. If the dollar
price is high enough, the exporter should follow through with the sale. Similarly, if
the dollar price on a foreign-currency-denominated import is low enough, the
importer should follow through on the purchase. All this rule does is to recognize
that a euro (or any other foreign currency) tomorrow is not the same as a euro today.
This rule is the international analogue to the insight that a dollar tomorrow is not the
same as a dollar today. In the case of a sequence of payments to be received at
several points in time, the foreign currency price should be a weighted average of
the forward rates for delivery in those dates.
1.6. Overview of Vietnam Foreign exchange market
1.6.1. Background of Vietnam’s exchange rate regime
In line with the broader economic reform process, Vietnam‟s exchange rate regime
has evolved from a system of multiple exchange rates to a single announced fixed
rate, then to the current system incorporating a narrow adjustable band around the
official rate, which is itself set on a daily basis and is meant to reflect the interaction
of market forces.

28


The changes in exchange rate regime have allowed the creation of the necessary
institutional framework for the formation and development of an organized foreign
exchange market in Vietnam. The country started to have an organized, modern
foreign exchange market since the early 1990s. There are two key milestones in
this process. The first was the establishment of two foreign exchange trading floors
(in 1991) and the second the birth of an interbank foreign exchange market (in
1994).
1.6.2. Vietnam’s exchange rate regime during 1994-2011 periods
(i) 1994-1996 - Conventional fixed peg arrangement
Replacement of the two foreign exchange transaction floors with an inter-bank
foreign exchange market.
Official Exchange rates were stable and set by the State Bank of Vietnam based on
inter-bank Exchange rates. The Exchange rate band within which Commercial
banks set their own Exchange rates remained narrow at 0.5%- 1% around the
official Exchange rate.
(ii) 1997-1998 - Crawling bands
The Exchange rate band was widened continuously, from 1% to 5% (02/97), and
from 5% to 10% (13/10/97).
Devaluation of the VND under pressure of falling foreign exchange reserves and
increases in balance of payment deficits.
(iii) 1999-2000 -Conventional fixed peg arrangement
Instead of declaring an official Exchange rate, since 26 Feb. 1999 the State Bank of
Vietnam began announcing average inter-bank Exchange rates of the previous
working day, but the band has been tightened remarkably to 0.1%.
(iv) 2001-2007 - Crawling peg
The average inter-bank Exchange rates were gradually adjusted from
14,000VND/USD (2001) to 16,100 VND/USD (2007).
The Exchange rate band was widen from 0.1% to 0.25% (07/2002) and from
0.25% to 0.5% (01/2007).

29


(v)2008-2011 - Crawling bands
Table 1.2- Changes of average inter-bank exchange rates and allowable
trading bands during 2008-2011 period.
Average inter-bank Exchange rates Allowable trading bands
(VND/USD) (%)
06/2008: 16,500 VND/USD 24/12/2007: 0.75%
01/2009: 17,000 VND/USD 10/03/2008: 1%
12/2009: 17,940 VND/USD 27/06/2008: 2%
02/2010: 18,544 VND/USD 07/11/2008: 3%
08/2010: 18,932 VND/USD
24/03/2009: 5%
02/2011: 20,693 VND/USD
26/11/2009: 3%
11/02/2011: 1%
Source: Various Decisions by the State Bank of Vietnam from 2008 to 2011
1.6.3. Mechanisms to support stability in the VND/USD rate
According to Nguyen Tran Phuc (2009), the current exchange rate regime operates
within the framework of an announced official exchange rate and an allowable
exchange rate band. These two devices have been used to slow down short-term
changes in the exchange rate, even when there was strong market pressure for either
a depreciation or appreciation of the domestic currency. When the resultant
commercial exchange rates failed to clear the market, the authorities tended to rely
on official intervention to meet part of the imbalance between demand and supply,
supplemented by moral suasion and administrative measures.
1.6.3.1. Official exchange rate
Since 1999 the State Bank of Vietnam has determined the average VND/USD
exchange rate on the interbank market on each banking day and announced it as the
official exchange rate on the following banking day. However, this determination
process has not been transparent and has contained to a large extent elements of the
subjective will of the State Bank of Vietnam. Additionally, the announced average

30


interbank rate has often appeared rather sticky or even rigid, despite evidence of
rapid developments in the market.
Table 1.3- Changes of average inter-bank exchange rates during 2007-2011
period.

Average inter-bank Exchange rates Change
01/2007 16,100 VND/USD
06/2008 16,500 VND/USD 2.48%
01/2009 17,000 VND/USD 3.03%
11/2009 17,940 VND/USD 5.53%
02/2010 18,544 VND/USD 3.37%
08/2010 18,932 VND/USD 2.09%
02/2011 20,693 VND/USD 9.30%

2006-2008: During this period, the State Bank of Vietnam pegs Vietnamese Dong
to US dollar at an annual devaluation of 1- 2% (mainly to handle the difference in
inflation between the two economies). In a stabilizing effort, State Bank of Vietnam
raised inter-bank exchange rate by 2.48%, from 16,100 VND/USD to 16,500
VND/USD on June, 2008.
2009: On December 25th 2008, the State Bank of Vietnam announced a new
exchange rate (17,000 VND/USD), with the dong depreciating by 3.03% against the
US dollar as compared to June, 2008. This move contributed to facilitating export,
controlling trade deficit, ensuring a sustainable international balance of payments,
limiting the expectation of exchange rate hike, hence assisting enterprises to
actively develop their stable business plans.
Also, in this year, short supplies of foreign currency have characterized the national
economy. The shortage appeared in the second quarter of the year, when export
companies held onto foreign currencies and refused to sell dollars to banks.
Commercial banks did not have foreign currencies to sell to businesses, but they did

31


have capital in foreign currencies since no one wanted to borrow in foreign
currencies for fear of further dollar price increases. To cool the market, in late
November, State Bank of Vietnam decided to narrow the foreign currency trading
band to curb the decrease of the dong‟s value and raise the interbank exchange rate
by 5.53% from 17,000 VND/USD to 17,940 VND/USD. Meanwhile, the Prime
Minister requested large state-owned groups and corporations to sell dollars to
banks and improve the supply.
2010-2011:
On February 10th , 2010, Central Bank decided to raise the average interbank
foreign exchange rate by 3.37 percent from 17,940 to 18,544 dong per US dollar.
Then the foreign exchange rate movements showed the very positive signals when
free market's foreign exchange rate was closer to the commercial banks.
On February, 2011, the State Bank of Vietnam has decided to lift the interbank
exchange rate by 9.3% from VND 18,932 to VND 20,693 to the dollar and
narrowed exchange rate amplitude from 3% to 1%. According to State Bank of
Vietnam‟s explanation, the adjustment of the exchange rate aims to promote the
liquidity of the foreign exchange market. State Bank of Vietnam said that it would
adjust the interbank average exchange rate flexibly in the near future according to
the foreign currency supply and demand situation, to ensure the liquidity of the
market, contribute to curbing the trade gap and help carry out monetary policies
more flexibly.
In conclustion, the State Bank of Vietnam tends to raise the interbank foreign
exchange rate in recent years in order to increase the market liquidity and foreign
exchange reserves, and especially to curb trade deficit. However, Vietnam's
economy relies heavily on material imports. A successful processing economy is
not allowed to be dependent on imports. Other countries have to devalue their
currencies whereby their export products will be more competitive. But theory is
not right as for a developing country like Vietnam. In Vietnam, strategic export
items such as apparel, footwear have the imported material ratio of over 80-90

32


percent. So, when devaluing the dong, the prices of material imports as well as the
prices of products will be higher, meaning that devaluing the dong will harm the
economy.
1.6.3.2. Allowable trading band
Figure 1.3- Allowable Variations around Official Exchange Rate Mar 1989 -
Mar 2011

Note: There was no lower band for the periods Aug 91–Sept 94 and Jan 98–Jun 02
The trading band, within which commercial quotations are allowed to fluctuate, has
been quite narrow except for the periods around the 1997-1998 Asian Financial
Crisis and the 2007-2008 Global Financial Crisis (see Figure 1.3). It would appear
that increases in the width of the allowable trading band have been used mainly to
respond to episodes of strong pressure for the VND to depreciate. In particular, the
repeated broadenings of the band in 1997 and 2008-2009 allowed the VND/USD
exchange rate to be adjusted upward in response to major external shocks. When the
immediate urgency had passed, however, the band tended to be narrowed again.
1.6.3.3. Official intervention
Given the operation of administered pricing, through the setting of both the official
exchange rate and the allowable trading band, frequent instances of non-clearance

33


of the market were unavoidable. By default, the State Bank of Vietnam often found
it necessary to intervene in order to manage such market imbalances, aiming at
keeping the exchange rate VND/USD at the required level and within the allowable
band.
During much of the period under study, the VND was under pressure to depreciate,
and there was a persistent excess demand for USD at the commercially quoted
exchange rates, which were already pushed to their upper limit. Accordingly, the
State Bank of Vietnam had to sell quantities of USD. Due to the need of conserving
official foreign exchange reserve, however, the State Bank of Vietnam tended to
meet only part of the prevailing excess demand, and to use administrative
arrangements to ration some of the available foreign exchange among potential
buyers. In particular, only those commercial banks with short positions exceeding a
certain size could approach the State Bank of Vietnam to buy foreign currency at
the quoted exchange rates. Moreover, the system allowed priority to be given to the
importation of essential goods (such as petroleum, fertilizer and medicine), and to
commercial banks that serve customers engaging in these priority activities. This
means that other customers must turn to the parallel black market or other channels
to address their unmet demand for USD.
1.7. Overview of Vietnam’s derivatives market
First appearing in developed markets in the 1980s, financial derivatives have been
used widely by commercial banks worldwide as risk-prevention tools. However, the
situation is different in Vietnam. Financial derivatives were first used in Vietnam
ten years ago (2000), but they are still far from popular in the country.
In fact, several derivatives products, including forward, swaps, options and futures,
have been provided by some prestigious banks such as Vietcombank, BIDV,
Techcombank, Eximbank and HSBC. However, the banks still cannot persuade
their clients to use the products more regularly.

34


1.7.1. Forward transaction
Forward transaction were first introduced about 10 years ago. This type of
transaction brings many advantages to customers:
Suitable for foreign trade settlement, overseas money transfer or investment
to hedge the fluctuation of exchange rate.
Customers may estimate in advance business expenses and incomes and
guarantee ability to make payment to other parties.
In forward transaction, Foward rate is caculated according to the formula (Phd Tran
Hoang Ngan, Phd Nguyen Minh Kieu,2008) :

(1) ~
F=S F=S+S

~F = S + Forward spread

Using a direct exchange rate: Home currency price of certain quantity of the foreign
currency quoted (Home currency/Foreign currency: VND/USD)
Rh: Interest rate of Home currency (%)
Rf: Interest rate of Foreign currency (%)
F: Forward rate
S: Spot rate
n: transaction term
(1)Based on the theory of Interest rate parity – IRP.
Before 28th May, 2004: according to the Decision 17/1998/QĐ-NHNN7 (10th Jan
1998), forward rate consists of two parts: the spot rate and the forward spread (also
known as forward points, forward pips, etc). Forward spread is expressed as either
premium spread or discount spread. Forward rate was determined as following
formula:

F = S + Forward spread

The Forward spread was determined by Percentage of Spot rate offered by State
Bank of Vietnam based on . For example:

35


Forward spread= 0,8%*Spot rate (of the signing day) for settlement after 7 days.
This way of forward rate determination was different with international practice and
could not keep up with the changes in the market. Also, settlement date was only be
at most 6 months after trade date. This did not meet the demand of many
companies. Thus, not many companies used forward transactions at that time.
After 28th May, 2004: According to Desicion No. 648/20 in 2004, Settlement date
was extented to be at most 365 days after trade date. Also, Commercial banks are
allowed to set the forward rate VND/USD so that it does not exceed the rate
computed on the basis of: (i) spot rate; (ii) interest differential between the base rate
of the dong and Fed Funds Target Rate of the US dollar; and (iii) forward term.
This way of forward rate determination moves closer to international practice.
We have the following formula:

Forward rate = S+ S*

rVND: Base rate of the dong
rUSD: Fed Funds Target Rate of the US dollar
Many banks provide forward transaction with similar features.
Eximbank
Transaction term: At least 3 days, at most 365 days.
Transaction fee: No fee required.
Documents: Economic entities, other organizations and individuals deposit VND to
buy foreign currencies from Eximbank have to present documents fully providing
information on the purpose, quantity and type of payment currency, payment time
in accordance with current Foreign Exchange control regulations.
Forward rate:
Forward rate of USD-VND transaction is the rate calculated on spot rate in the trade
date and the difference between VND basic interest rate of State Bank of Vietnam
(on yearly basis) and the USD target interest rate of US Federal Reserve Bank.

36


Forward rate of VND against foreign currencies (except USD) transaction and
forward rate between foreign currencies is based on the negotiation.
Table 1.4- Spot rate and forward rate of Eximbank on March 2011 (For
reference)
USD/VND Exchange rate
nd
Date 22 March, 2011
Rate Transaction term Bid Ask
Spot rate 20,885 20,890
01 week 20,921 20,926
02 weeks 20,956 20,961
01 month 21,037 21,042
02 months 21,200 21,205
Forward rate
03 months 21,342 21,347
04 months 21,494 21,499
05 months 21,646 21,652
06 months 21,849 21,855
Average interbank exchange rate: 20,683VND/USD
Trading band: 3%
Note: These statistic can be varied during a day.
Source: Eximbank ‘s Treasury Department
Procedures:
Contact with the Treasury Department to sign a forward contract.
3% deposit of the contract value for USD/VND transactions is required.
7%-10% deposit of the contract value is required for transactions other than
USD/VND transactions.
 Up to the present time, outright forward account for only about five to six
percent of total foreign exchange trading turnover. Such a share is very small by
international standard. In addition to low trading volume, the forward segment
appears to have abnormal and immature characteristics.
First, the selling-buying structure of forward trading by commercial banks
has been exceedingly imbalanced: the turnover of forward-selling by

37


commercial banks made up around 75-85 percent of total forward trading
(Nguyen Tran Phuc 2009, pp.15).
Second, commercial banks have tended to be quite passive in taking the role
of market-makers in the forward market. Vietnamese commercial banks
generally do not make their quotation ready for forward transactions, in both
client and interbank market. Any quotation can be obtained only upon a
request. (Luu Minh Ngoc, 2008, as cited in Nguyen Tran Phuc, 2009, pp.15)
Third, the determination of forward rate VND/USD still contains
administrative elements. According to a guidance in 2004, commercial
banks are allowed to set the forward rate VND/USD so that it does not
exceed the rate computed on the basis of: (i) spot rate; (ii) interest differential
between the base rate of the dong and Fed Funds Target Rate of the US
dollar; and (iii) forward term. This way of forward rate determination moves
closer to international practice, but the mentioned reference interest rates
may not reflect the true market interest rates that market participants realize
in their transactions. This suggests that the current guidance has tended to
hold back the ability of commercial banks in acting as market-makers as
well.( Nguyen Tran Phuc 2009, pp.15).
1.7.2. Currency options
Currency options were first introduced by Eximbank into Vietnam‟s forex market in
2003. Currency Option contract is a contract between buyer and seller of an option
in which buyer has the right (but not the obligation) to buy or sell a certain currency
amount at a predetermined exchange rate at or prior to a certain expiration date. If
buyer chooses to exercise the right, seller has a duty to sell or buy that currency
amount at a stated rate as specified in the contract.
Some advantages of currency options:
To hedge the risk of exchange rate fluctuation as well as to help customers to
get profitable opportunities if exchange rate changes appropriately.

38


Able to predetermine minimum fee (premium) of a Call Option or minimum
profit of a Put Option.
To provide customers with an acceptable rate.
Have a chance to speculate on F/X fluctuation with a fixed premium and
unlimited profit.
Eximbank
Styles:
American style: the option can be exercised at any time during its validity.
European style: the option can only be exercised at the contract maturity date.
Eligible users:
Buyer: eligible individuals or entities living or operating in Vietnam
Seller: Eximbank
Transaction premium: The amount that buyers have to pay for the bank (sellers) to
get the option.
Table 1.5- Option transaction premium of Eximbank in March 2011
Reference transaction premium
st
21 March 2011
Style American
USD/JPY (Unit: pips) (strike price 80.90) Call Option Put option
01 week 82 85
Transaction period 02 weeks 99 102
01 month 126 130
EUR/USD (Unit: pips) (strike price 1.4170) Call Option Put option
01 week 85 89
01 month 197 203
GBP/USD (Unit: pips) (strike price 1.6220) Call Option Put option
01 week 95 97
01 month 181 186
Transaction period: from 3 days up to 365 days
Note: These statistic can be varied during a day.
Source: Eximbank ‘s Treasury Department

39


Exchange rate: The exchange rate agreed by the two parties and specified in the
contract.
Transaction currencies: USD, GBP, CHF, JPY, AUD, CAD, EUR
Amount: Equivalent to at least USD$100,000 (one hundred thousand US dollars)
for each contract.
Transaction period: from 3 days up to 365 days
Contract validity: The period that option can be done by the requirements of buyers
from the contract signing date to before 11:00 (Hanoi time) of the contract maturity
date.
Documents: No need for any documents certifying the purpose of currency use
Contract Exercise: When in need of implementing the contract, customers submit
the Request for Contract Exercise to Eximbank.
*** In 19th March,2009, the Government has issued a decision under Decree
160/2006/NĐ-CP to stop offering option contract between Vietnam dong and other
foreign currency since 23rd March, 2009.
1.7.3. Swap
Foreign exchange swaps have been so far used for the purpose of injecting local
currency into circulation only. They were first allowed in 1998. However, it was not
until July 2001 that the first deals were actually done when the State Bank of
Vietnam issued a guidance on the implementation of foreign exchange swaps
between the State Bank of Vietnam and commercial banks to assist the latter in
overcoming temporary shortages of fund in local currency. Such specified
transactions were popular in years 2001-2002 with transaction volumes of several
hundred million US dollars, helping commercial banks use sources of fund in
foreign currency flexibly. Yet, they became quiet in the following years with a
small transaction volume.
Some benefits of currency options:
Cheaper than cash markets by issuing foreign currency bonds directly.
Can select to exchange principal at the start if desired.

40


Simple documentation procedure compared to cash markets through issuing
a bond or arranging a loan.
Customised and can be reversed at any time.
Off Balance Sheet.
Suitable for hedging long-term transaction exposures.
Be fully hedged against foreign exchange risks in terms of both principal and
coupons.
The obtainment of capital in the required currency, in the necessary volume
and with the required due term.
Eximbank
Decription: Cross Currency Swap services include 2 transaction:
Spot transaction +Forward transaction
Forward transaction+ Forward transaction
Eligible users:
Buyer: Entities living or operating in Vietnam
Seller: Eximbank
Exchange rate: The spot exchange rate at the time of doing the deal determines the
principal amounts.
Transaction term: At least 3 days, at most 365 days.
Transaction fee: No fee required.
Documents: No need for any documents certifying the purpose of currency use
Procedures:
Contact with the Treasury Department to sign a forward contract.
3% deposit of the contract value for USD/VND transactions is required.
7%-10% deposit of the contract value is required for transactions other than
USD/VND transactions.
1.7.4. Evaluation
There are some reasons why Vietnamese companies are quite indiferent to
derivatives products:

41


Most Vietnamese companies did not have good understanding of
complicated operations of how to use these derivatives products. For
example, It took HSBC Vietnam six months to explain and negotiate with a
client before a swap contract was reached.
The turnover from derivatives products is not big enough for Vietnamese
banks to spend more time and money to attract clients.
The policy on stabilising the VND/US$ exchange rate has also led to the fact
that companies do not pay appropriate attention to these products. Currently,
the official VND/USD exchange rate has followed a gradual upward trend
with very little volatility except for the periods of the Asian Financial Crisis
and the recent World Financial Crisis. This gives rise to a high degree of
predictability and an expectation among market participants that the State
Bank of Vietnam will frequently intervene to limit volatility in the official
rate. The low volatility of the exchange rate, coupled with the one-way
nature of most daily movements, means that businesses generally perceive
little foreign exchange risk. As a result, there is little incentive for market
participants to develop greater sophistication in terms of ability to form
views regarding the future paths of the exchange rate, or to manage exchange
rate risks.
Most credit loans on the market apply fixed interest rates (90%), and with
fixed interest rates, borrowers do not need derivatives products to minimize
risks from interest rate fluctuations.
In conclusion, we can say that there is little need for derivative products as a means
of risk management during normal times. However, when exchange rates did
become more volatile (for example, during the recent World Financial Crisis),
hedging devices would have been very useful means to manage exchange rate risks.

42


CHAPTER 2- RISK ANALYSIS OF TRANSACTION EXPOSURE

2.1. Profile of CNT
2.1.1. Introduction

Established: 1976
Name in Vietnamese: CÔNG TY CỔ PHẦN XÂY DỰNG VÀ KINH DOANH
VẬT TƯ
Name in English: CONSTRUCTION AND MATERIALS TRADING JOINT
STOCK COMPANY
Director: Mr Pham Anh Tuan
Charter Capital: VND 100,150,690,000
Registered and Corporate Office: 9-19 (Floor 6) Ho Tung Mau Street District 1
Ho Chi Minh City
Website: www.CNT.com.vn
Table 2.1- List of shareholders holding over 5% as of May 14, 2010
Number
Owner
Name of Shareholders Address of
percentage
Shares
Construction Corporation 111 Pasteur P. Ben Nghe 3,450,000 34.50%
No.1 Ward, Dist 1, HCM city
VietNam Property TMS Building, Floor 12, 172 1,939,975 19.39%
Holding Hai Ba Trung, Dist 1 HCM
city
Source: Prospectus 2010

43


2.1.2. Establishment and history
Figure 2.1-Establishment and history of CNT

28/05/1976
Established with initial name Transport Materials Supply Enterprise directly
under Construction Corporation No.1

26/05/1981
Ministry of Construction signed Decision to change Transport Materials Supply
Enterprise to Transport Materials Supply Company.

24/02/1990
The company was renamed Construction and Materials Supply Company.

15/01/2003
The Ministry of Construction promulgated decision concerning equitizing the
company with the new name Construction and Materials Trading Joint Stock
Company (C&T).

04/03/2003
Department of Planning and Investment of Ho Chi Minh city issued the
business registration certificate No 4103002148.

28/07/2008
C&T was the 155th company officially listed in Ho Chi Minh City‟s Stock
Exchange under the code CNT.

01/01/2009
Vietnam Steel Association certified C&T as official member.

44


2.1.3. Vision and mission
a. Vision
Until 2015, CNT continues to be a diversified company with the leading position in
the fields of construction, materials trading and real estate business; maintaining the
steady growth in infrastructure construction, industrial production and real estate
investment.
b. Mission
Strive to provide customers with the high quality products and good services at the
competitive price, making a significant contribution to the national economic
growth.
Strengthen management system, increase efficiency of capital utilization and
transparency in business activities.
Concentrate on raising employees‟ salaries and creating surplus values to
shareholders.
Build up the specific characteristic of the company culture: Grow up together.
Link the individual success with the growth of the company and be dedicated to
national community development.
2.1.4. Scope of Business
2.1.4.1. Construction
With experienced engineers and over 2000 skilled workers, CNT has performed
civil, industrial projects, foundation and infrastructure projects which have been in
highest rank and project progress completion on time. Since 2000, CNT has
invested lots of machinery, manpower, and applied new technology in construction
field. As a result, CNT becomes one of the best construction companies of
Construction Corporation No.1.
2.1.4.2. Investment
CNT has been carrying out many investment projects since 2003, especially real
estate investment and industrial production. At present, CNT is concentrating all
financial efforts on investing and building the complex commercial office-

45


apartment (Green Pearl City) at An Phu Ward, District 2, Ho Chi Minh City. This
project is regarded as CNT‟s key investment and trading project from 2010-2012.
2.1.4.3. Industrial and construction material production
CNT has produced the industrial products and construction materials as follows:
- Various kinds of construction stones
- Reinforced concrete pile and others such as centrifugal round drains, box
drains, girders, etc.
- Various kinds of PP packing (for Baltic – Europe)
2.1.4.4. Import - export trade
With skilled staff in foreign trade activities, full of prestige in mandating import
export services, CNT has won the contracts to supply the imported materials and
equipment for many large projects and raw materials for the construction material
production factories such as clinker, rough steel, etc. The company has had the
representative office in Ukraine, China since 2003 and business promotion in the
U.S.
2.1.4.5. Local product trade
CNT has much experience for many years in the material and equipment supply to
the large projects of Construction Ministry and Construction Company No. 1 such
as Tri An Hydroelectric Plant, Thac Mo Hydroelectric Plant, Vung Tau Petroleum,
Da My Ham Thuan Hydroelectric Plant, Sao Mai Hon Chong Cement Factory,
National road No.1 upgrading contract R.100, Xuyen A Highway, Dong Tay
Boulevard, water environment projects, etc.

46


2.1.5. Organizational structure
Figure 2.2- Organizational structure

Source: Prospectus 2010

47


2.1.5.1. General Shareholder’s Meeting
General Shareholder's Meeting is the body with highest decision power of CNT
including all shareholders with voting right and held at least once a year. General
Shareholder's Meeting decides on the issues regulated by the Laws and the Articles
of Association of CNT such as Passing annual financial statements of CNT and
financial budget for the subsequent year; electing, dismissing or releasing members
of the Management Board, Supervisory Board
2.1.5.2. Board of management
Board of Management has 05 members, two of which are independent of
management. Board of Management is the body managing of the Company, which
is entitled to act on behalf of the Company in exercising all the rights and
obligations, except those falling under the authority of the Shareholders Meeting.
2.1.5.3. Board of supervisors
The chief supervisor of the Company has expertise in accounting, working
independent of finance and accounting department.
2.1.5.4. Board of directors
Full names Position Appointing date
1. Mr. Pham Anh Tuan General Director December 2006
2. Mr. Do Đuc Minh Vice General Director December 2006
3. Mr. Hoang Ngoc Minh Vice General Director May 2004
4. Mr. Phan Trung Huy Vice General Director January 2010
5. Mr. Phung Dat Duc Vice General Director June 2005
6. Mr. Tran Cong Quoc Bao Vice General Director October 2006
2.1.5.5. Functional departments
Administration Department
Finance and accounting Department
Planning and investment department
General department
Construction department

48


Sale department
2.1.6. Human resources
Table 2.2-Staffs and employees (2010)
Quantity Percentage
Level
(People) (%)
University and postgraduate 161 28%
College 16 3%
Genaral employees 405 69%
Total 582 100%
Source: Annual report 2010.
Figure 2.3- Staffs and employees

Staffs and employees (2010)
University and
postgraduate
28%
College
Genaral
3%
employees
69%

As Table 2.1 shows, employees with college, and university and postgraduate
education makes up approximately 31% of total employees. The general employees
are around 69% of all the employees. In general, most of the employees in CNT
have enough qualification to take on important responsibilities and carry out large-
scale projects. In some cases, there are not enough employees to meet demand of
the company, especially when the company has to carry out big projects. The main
reason is because the company does not have many recruitment programs and
training programs to attract more qualified employees. Moreover, in the context
where the market in general lacks highly qualified human resources, human
resources for Construction and International business become more difficult.
2.1.7. Business performance
2.1.7.1. Profit structure

49


Table 2.3- Profit structure of CNT during 2006-2010 (Unit: Million VND)
2006 2007 2008 2009 2010
Items
Value % Value % Value % Value % Value %
Net operating profit 11,958 79% 21,802 94% 21,720 78% 24,313 47% 16,138 63%
Profit from sale 31,332 38,404 85,161 58,469 81,073
Financial profit (loss) -19,374 -16,602 -63,441 -34,156 -64,935
Profit in business concerns
- - - - 2,962 11% 26,370 51% 5,997 24%
and joint venture
Other profit 3,270 21% 1,396 6% 3,207 11% 751 2% 3,281 13%
Total accounting profit 15,228 100% 23,198 100% 27,889 100% 51,434 100% 25,416 100%
Profit after tax 13,208 100% 20,040 100% 21,498 100% 45,889 100% 21,099 100%
Change in 2007 Change in 2008 Change in 2009 Change in 2010
compare with 2006 compare with compare with compare with
Items
2007 2008 2009
Value % Value % Value % Value %
Net operating profit 9,844 182% -82 100% 2,593 112% -8,175 66%
Profit from sale 7,072 123% 46,757 222% -26,692 69% 22,604 139%
Financial profit (loss) 2,772 - -46,839 - 29,285 - -30,779 -
Profit in business concerns
- - - - 23,408 890% -20,373 23%
and joint venture
Other profit -1,874 43% 1,811 230% -2,456 23% 2,530 437%
Total accounting profit 7,970 152% 4,691 120% 23,545 184% -26,018 49%
Source: Financial report 2007-2009

50


Figure 2.4- Profit structure of CNT during 2006-2010 Chart

Profit structure of C&T during 2006-2010
60000
50000 Total accounting profit
Million VND

40000
Net operating profit
30000
20000 Profit in business concerns and
joint venture
10000
Other profit
0
2006 2007 2008 2009 2010

Based on these data, The Total accounting profit is increasing year-by-year,
reflecting the efforts to expand operation and increase profit. Net operating profit
makes up a relatively large proportion of Total accounting profit of the company.
In 2007, the value of Net operating profit stood at VND 21,802 million, up 82
percent compared with 2006. In that year, foreign direct investment continuously
gained extremely good results. This investment mainly focused on industry and
construction sector. Therefore, the increasing demand of building materials gave
rise to revenue and profit from sale of the company.
In 2008, CNT showed similar performance with 2007. Especially, the Profit from
sale, which is a major part of net operating profit, climbed to VND 85,161 Million
or 122 percent year-on-year increase thanks to the joining of Vietnam into the
World Trade Organisation (WTO) and the positive situation of material market in
the beginning of the year. In that year, the Financial cannot compensate the
financial expenses which mostly consists of loan interest expenses and exchange
loss...Exchange rate fluctuations in 2008 resulted in an Financial loss of VND
63,441 Million which affected negatively the Net operation profit.
In 2009, the value of Net operating profit represents VND 24,313 Million, up 12
percent against the same period in 2008. The profit from sale decreased by VND
26.6 billion (down 31 percent in comparison with that of the previous year) due to
the decrease of the sales from iron and steel. That year, we saw a sharp increasing in

51


Profit in business concerns and joint venture which leaded to a significant change in
profit structure. The main reason for this change is because the company‟s financial
income of the current year has increased considerably in comparison with that of the
previous year due to the interest from transferring 50% of share capital in its
subsidiary (An Phuc Construction and House Trading Limited Company).
One general trend that can be seen from this table is that the value of Financial
loss always causes decreasing in operating profit. Specifically, the loan interest
expenses is much higher than financial income. The main reason is that CNT‟s
trading activities are frequently funded through loan finance. Therefore, the increase
of inflation rate and loan interest as well as the tight monetary policies of
Vietnamese Government can have adverse impacts on CNT‟s financial situation.
Even though the company has increased the charter capital to 80 billion VND, this
cannot meet the demand for development of the company.
In 2010, the Net operating profit was approximately 16,138 million VND, declined
44 percent in turnover. In recent year, the construction materials market is growing
strongly alongside rapid urbanization. Also, Vietnam's building materials
manufacturers have been unable to meet the demand from contractors for a large
amount of materials. Therefore, the profit from sale soar nearly 22,604 Million
VND to 81,073 Million VND in 2010. However, the net operating profit in this
period suffered from a sharp decrease. The rapid increase of financial loss is the
main reason for this problem. In this year, we saw a sharp increase in financial loss,
mainly from the loss of financial income (Interests on capital transfer) compared
with the same period in 2009.

52


2.1.7.2 The situation of import activity
2.1.7.2.1. Import-turnover
Table 2.4- Import-turnover 2008-2010
(Unit: Million VND)
2009 compared 2010 compared
Item 2008 2009 2010 with 2008 with 2009
Value % Value %
Import-turnover 465,751 529,472 458,789 63,721 114 -70,683 86
Source: Accounting department.
The import-turnover in 2009 reached 529,472 million USD, account for an
increasing of 14% in comparison with import-turnover in 2008. In 2010, in the
context of financial crisis, the business in the year of 2010 was really a challenge
for the company due to the lack of capital and low demand. Particularly, the import-
turnover reached over VND 458,789 Million or 13 percent down in volume
compared with 2009 due to the following reason:
The Company had to solve the quantity of stocks from the year of 2009.
The domestic demand of building materials was decreased. For this reason,
the import-turnover of some types of steel (having large proportion in import
turn-over) was reduced.
Import price has seen a sharp increase in 2010. Vietnamese Government
raised the import taxes on steel billet to 5%-8% to protect the domestic steel
industry. The customer tends to use domestic building materials to reduce
cost.
The Vietnam‟s building material industry has made a remarkable progress
comparable to that of the world‟s industrially developed countries and thus
met increasing demands of domestic construction firms as well as foreign
investors engaged in Vietnamese construction industry.

53

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