Case study Allied Lyons, a large multinational food and drink conglomerate, headquartered in the United Kingdom exposes

itself through its worldwide manufacturing and distribution activities to foreign exchange transactions and translation risk. Transaction exposure results primarily from exports sales or imports purchase on credit that Allied Lyons consummates with foreign parties. For example, a shipment of 100,000 bottles of Canadian Club whisky to Japan would create a 90-day 500 million yen denominated account receivable which Allied Lyons may decide to hedge should it concern by the possibility of the yen depreciating between the time of shipment (when the receivables is booked) and actual payment time 90 days later. Furthermore, multinational corporations such as Allied Lyons are required to report to their shareholders on a quarterly basis their worldwide performance from both the parent firm and their foreign operations in the form of simple statistics consolidated earnings and the much awaited and studied earnings-per-share. Unfortunately, the firms treasurer CFO foreign subsidiaries prepare their results in the currency of the country in which they operate for example Yen for a Japanese subsidiary, different from the parents currency risk which is pound sterling. It means that their financial results will have to be converted or translated from the foreign currency into the parents currency (pound sterling). Because exchange rate may have changed since the last translation, the multinational corporations net worth may increase or decrease: this risk is rooted in the translation exposure resulting from foreign affiliates ongoing operations. With major operations in the United States, the dollar figured prominently on Allied Lyons portfolio of both transaction currency exposures. Allied Lyons treasury department would in the normal course of business be charged with hedging the companys stream of foreign currency revenues/costs such as receivables, payables or dividends (transaction exposure) as well as the value of foreign subsidiaries net worth (translation exposure) against foreign exchange surprises. With long or short positions in several foreign currencies such as US dollar, Japanese Yen, German mark, Korean won, French franc Allied Lyons would sell/buy forward in the foreign currency at risk thus, locking in their pound value. Currency options for a fee known as premium would also allow Allied Lyons to hedge against downside risk while appropriating the profits from exchange currency potential appreciation. In the mid-1980s, Aliied Lyons acquired Hiram Walkers spirit business whose heir, Chairman and CEO Clifford Hatch, became one of Allied Lyons directors and in 1987, its finance director, Hatch, born into wealth and used to authority and autonomy, moved promptly to re-organise the finance department asserting its independence from Sir Derrick Holden-Brown, Allied Lyons autocratic and paternalistic Chairman. His treasury team was now five men strong and led by the Boston. Confident enough of his trading savvy to audaciously navigate the high seas of the turbulent foreign exchange market, Barlett went on record in November 1989 in an article published in the Treasurer: We wanted to hedge a long sterling position in a trendless market. We thought of buying sterling puts, but volatility was at all time high so instead we sold sterling calls Interestingly, Allied Lyons reported GBP$3 million in foreign exchange profits for the year closing in March 1988, GBP$5 million in 1989 and GBP 9 million by 1990 which, as

Euromoney notes, compares favorably with giant oil company British Petroleums GBP 23 million in foreign exchange profits for the same period. The ultimate result was when the treasurer could no longer hide the losses and had to confess in 1991 to the lost of $270 million. The chairman of Allied-Lyons took responsibility for allowing the treasurer to engage in such speculation and resigned. Guidelines to Report Format: a. Identify and discuss Allied Lyons problems in particular the difference between transaction and translation exposures faced by the company. b. Provide examples on how Allied Lyons should go about considering the appropriate hedging strategies using currency derivatives their exposures covering both transactions and translation exposures. c. Highlight the potential political risks d. Conclusion