The Effects of Financial Risk

As we shall see, companies are vulnerable to changes in macroeconomic factors. The following examples show how changes in economic factors are affecting corporate performance.

Polish companies in bad bets against the zloty

In 2009, the Polish government stepped in to help companies such as Elwo, which had undertaken extensive transactions in anticipation of a rise in the zloty against the US dollar and the euro only to find the zloty suddenly fall against these currencies in the wake of developing problems in Eastern Europe in the aftermath of the credit crunch. The US dollar gained 70 per cent and the euro 40 per cent as investors fled problematic currencies. Commenting on the problems facing companies such as Elwo, the Financial Supervision Authority estimated that Polish companies had lost 5.5 billion zlotys ($1.6 billion; €1.2 billion; £1.1 billion) from similar transactions. After the bankruptcy filing by Elwo, the chief executive of its parent company stated: ‘In retrospect I can only say we chose bad instruments.’

Cargill profits decline 66 per cent

Cargill, the world’s largest agricultural commodity trader, reported a 66 per cent decline in first-quarter profits. It made a profit of $236 million in the first three months of 2011, compared to $693 million in the first three months of 2010. At the same time, revenues rose by 34 per cent to $34.6 billion, which, when combined with the fall in profits, meant that Cargill suffered a significant reduction in its profit margins. The company indicated that the significant volatility in financial and commodity markets and in particular its results reflected the ‘stress in financial markets caused by growing economic, fiscal and political concerns on both sides of the Atlantic’ (the US and Europe).

Allied Irish Banks suffers from low interest rates

The 1998 profitability of Allied Irish Banks (AIB) was adversely squeezed, despite a 15 per cent increase in pre-tax profits to Irish punts (IR£)826 million, up from IR£718 million in 1997, as a result of low interest rates squeezing its net interest margin (the net difference between the rates at which it lends and borrows funds). This fell by 33 basis points (a basis point is one-hundredth of 1 per cent) to 3.33 per cent in 1998. AIB further indicated that, as a result of the introduction of a common interest rate in countries participating in the European Monetary Union, a further reduction in margin was to be expected in 1999.

General Mills and ConAgra

The US food company General Mills saw increased sales in the first quarter of 2011, rising 9 per cent year on year. However, at the same time, profit margins suffered and net earnings fell to $405.6 million from $472.1 million for the same period the previous year, a decline of 14.1 per cent. The company indicated that it expected its raw material costs, mostly agricultural commodities, to increase by 11 per cent over the forthcoming year. The performance of General Mills has to be contrasted with that of its rival ConAgra, which reported a 42 per cent year-on-year drop in net income as a result of rising input costs. Its net income dropped to $85.3 million, down from $146.4 million. This example indicates how active risk management can help to overcome the problems of economic factors:

Japanese government provides aid to help exporters

In August 2011, the rapid rise in the Japanese yen (JPY) against the US dollar and the euro prompted the Japanese government to offer short-term financial support to exporters hurt by the yen’s strength. Over the previous year, the JPY had risen from JPY95 to the US dollar to JPY76 to the US dollar – a post-war record – and a currency appreciation of 25 per cent. The loss of international competitiveness in the American and European markets for Japanese exports and the poor outlook for the global economy prompted policy makers to turn to inventive policies to help Japanese export industries. These policy initiatives followed two failed currency interventions by the Bank of Japan designed to drive down the exchange rate.