Use of Derivatives in Toyota

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  • Topic: Derivative, Derivatives, Interest rate swap
  • Pages : 5 (1278 words )
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  • Published : October 17, 2009
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INTERNATIONAL FINANCIAL MARKETS
*“USE OF DERIVATIVES IN A CHOSEN COMPANY*”
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TABLE OF CONTENTS
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11.
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13.REFERENCES AND BIBLIOGRAPHY
TOYOTA MOTOR CORPORATION
1. INTRODUCTION
*2. FOREIGN EXCHANGE RISK IN *TOYOTA
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http://www.indexmundi.com/xrates/graph.aspx?c1=JPY&c2=USD&days=5475 2.2 *De*rivative products used by for foreign exchange risk Translation Risk Translation risk management
Transaction Risk Transaction risk management
Non derivative management
2.2 Derivative products used for foreign exchange risk
a) Foreign exchange forward contracts
b) Foreign currency options
Toyota uses currency option to exchange the money denominated in one currency to exchange money denominated in other currency at a pre-agreed exchange rate(Eun,C.S,p.114). It is different from the forward contract in that Toyota has right but not the obligation to exchange the currency and options have premiums and hence costlier than forward contracts. Foreign currency borrowing Foreign currency swaps 2.3 Effectiveness of Foreign Currency Exchange Rate Risk Management. *2.4 Alternative strategies to manage Foreign Exchange risk of *Toyota a) Futures Contracts

b) Leading and Lagging
c) Netting
Netting can be used to minimise foreign exchange risk. Netting is beneficial when large number of foreign exchange transactions occurs between subsidiaries of companies such as Toyota (Eiteman,D.K,p.2001). Netting is basically maintaining equal level of foreign payables against foreign receivables. The payment that remains exposed to foreign exchange risk can be hedged(Hull,J,C.p.614).The benefit of hedging is that it helps to reduce the foreign exchange conversion fees and the fund transfer fees on foreign exchange transactions. Moreover netting helps to settle the obligations quickly. *3. INTEREST RATE RISK IN *TOYOTA

3.1 Impact of Interest rate Risk on operation
Toyota also faces Interest rate risk due to its high involvement in financing, investing and cash management activities. The fluctuation of interest rates in various countries is shown below. From the figure we can see that in US the interest rates are very volatile hence effective interest rate risk management is very essential. {draw:frame}

Figure: Variation of Interest rates in US(AshrafLaidi,2009) http://www.ashraflaidi.com/charts/global-interest-rates.asp In order to maintain the desired level of risk exposure and to reduce interest expenses, Toyota uses different derivatives products and has been quite successful in minimizing interest rate expenses. 3.2 Der*ivative products used f*or Interest rate risk

a) Interest rate swaps
Interest rate currency swap Interest rate currency swap is a derivative product in which currency swaps are combined with interest rate swaps (Hull,J,C,p.707). Toyota would swap a fixed debt denominated in US dollars for a floating rate debt denominated in Euro. * c) Interest rate option*s

Interest rate options are options on financial assets whose prices are sensitive to changing interest rates (Hull,J,C,p.707).Toyota uses interest rate options to manage interest rate risk. *3.3 Effectiveness of Interest *Rate Risk Management

Toyota usually uses interest rate swaps, interest rate currency swap agreements and interest rate options to manage its risks. Toyotauses many strategies to minimize the risk in interest rate expense. Toyota estimated a loss by ¥99.5 billion by a 100 basis points upward shift in interest rates in fiscal year 2007 and by ¥110.6 billion in fiscal year 2008(Toyota,2008). Interest...
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