Evaluating Transaction Exposures and Hedging Solutions for Importing Steel at Construction and Materials Trading Joint Stock Company. Essay

Custom Student Mr. Teacher ENG 1001-04 24 March 2016

Evaluating Transaction Exposures and Hedging Solutions for Importing Steel at Construction and Materials Trading Joint Stock Company.

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 techniques Operational techniques Netting and offsetting Currency of invoicing Leading and lagging

Forwards and future

Money market hedge

Swaps

Options

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

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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

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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

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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.

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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).

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(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 (VND/USD) 06/2008: 16,500 VND/USD 01/2009: 17,000 VND/USD 12/2009: 17,940 VND/USD 02/2010: 18,544 VND/USD 08/2010: 18,932 VND/USD 02/2011: 20,693 VND/USD Allowable trading bands (%) 24/12/2007: 0.75% 10/03/2008: 1% 27/06/2008: 2% 07/11/2008: 3% 24/03/2009: 5% 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

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

Source: Various Decisions by the State Bank of Vietnam from 2008 to 2011 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

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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

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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 Source: Various Decisions by the State Bank of Vietnam from 1989 to 2011 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

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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.

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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) : F=S (�� + ����) (1) ~ (��+ ����)

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:

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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. (��������−��������) ������∗������

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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 Date 22 March, 2011 Rate Transaction term Bid 20,885 Spot rate 01 week 20,921 02 weeks 20,956 01 month 21,037 02 months 21,200 Forward rate 03 months 21,342 04 months 21,494 05 months 21,646 06 months
21,849 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: nd

Ask 20,890 20,926 20,961 21,042 21,205 21,347 21,499 21,652 21,855

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

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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.

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 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 21st March 2011 Style USD/JPY (Unit: pips) (strike price 80.90) 01 week Transaction period 02
weeks 01 month EUR/USD (Unit: pips) (strike price 1.4170) 01 week Transaction period 02 weeks 01 month GBP/USD (Unit: pips) (strike price 1.6220) 01 week Transaction period 02 weeks 01 month Transaction period: from 3 days up to 365 days Note: These statistic can be varied during a day. Source: Eximbank ‘s Treasury Department American Call Option Put option 82 85 99 102 126 130 Call Option Put option 85 89 119 121 197 203 Call Option Put option 95 97 128 132 181 186

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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.

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 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:

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 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.

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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 Holding Property TMS Building, Floor 12, 172 1,939,975 19.39% Hai Ba Trung, Dist 1 HCM city Source: Prospectus 2010

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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.

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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-

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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.

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2.1.5. Organizational structure Figure 2.2- Organizational structure

Source: Prospectus 2010

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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 1. Mr. Pham Anh Tuan 2. Mr. Do Đuc Minh 3. Mr. Hoang Ngoc Minh 4. Mr. Phan Trung Huy 5. Mr. Phung Dat Duc 6. Mr. Tran Cong Quoc Bao Position General Director Vice General Director Vice General Director Vice General Director Vice General Director Vice General Director Appointing date December 2006 December 2006 May 2004 January 2010 June 2005 October 2006

2.1.5.5. Functional departments  Administration Department  Finance and
accounting Department  Planning and investment department  General department  Construction department

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

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

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 largescale 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

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Table 2.3- Profit structure of CNT during 2006-2010
Items Net operating profit Profit from sale Financial profit (loss) 2006 Value 11,958 31,332 -19,374 3,270 21% % 79% 2007 Value 21,802 38,404 -16,602 1,396 23,198 20,040

2008 % 94% Value 21,720 85,161 -63,441 6% 100% 100% 2,962 3,207 11% 11% % 78%

2009 Value 24,313 58,469 -34,156 26,370 751 51,434 45,889 51% 2% 100% 100% % 47%

2010 Value 16,138 81,073 -64,935 5,997 3,281 25,416 21,099 24% 13% 100% 100% % 63%

Profit in business concerns and joint venture
Other profit Total accounting profit Profit after tax

15,228 100% 13,208 100%

27,889 100% 21,498 100%

Items

Net operating profit Profit from sale Financial profit (loss) Profit in business concerns and joint venture Other profit Total accounting profit

Change in 2007 Change in 2008 compare with 2006 compare with 2007 Value % Value % 9,844 182% -82 100% 7,072 2,772 -1,874 7,970 123% 43% 152% 46,757 222% -46,839 –

Change in 2009 compare with 2008 Value % 2,593 112% -26,692 29,285 23,408 -2,456 23,545 69% 890% 23% 184%

Change in 2010 compare with 2009 Value % 66% -8,175 22,604 -30,779 -20,373 2,530 -26,018 139% 23% 437% 49%

1,811 230% 4,691 120%

Source: Financial report 2007-2009

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

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

Total accounting profit Net operating profit Profit in business concerns and joint venture Other profit 2006 2007 2008 2009 2010

40000 30000 20000

10000
0

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

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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.

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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 with 2008 with 2009 Item 2008 2009 2010 Value % Value % 114 -70,683 86 Import-turnover 465,751 529,472 458,789 63,721 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 importturnover 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.

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2.1.7.2.2. Distribution of imports by commodity Table 2.5- Distribution of imports by commodity (Unit: Million VND) Items 1.Types of Iron 2.Steel Beams H Steel Beam Steel sheet Steel plate Steel bar 3.Construction equipment 4.Other materials Steel billet Steel sheet pile Prestressing teel strand Import-turnover Source: Accounting department. 2008 Value Pro. 55,655 11.9 168,270 36.1 121,508 26.1 8,314 1.8 10,047 2.2 426 0.1 241,826 51.9 53,362 11.5 59,761 12.8 17,352 3.7 465,751 100 2009 Value Pro. 119,642 22.6 190,582 36.0 43,024 8.1 22,870 4.3 123,583 23.3 1,105 0.2 219,248 41.4 72,549 13.7 53,597 10.1 39,987 7.6 529,472 100 2010 Value Pro. 100,459 21.9 143,806 31.3 77,997 17.0 61,946 13.5 5,714 1.2 208,810 45.5 80,915 17.6 14,861 3.2 458,789 100

Based on Table 2.5, Steel Beams makes up an appreciable proportion of the company‟s import turnover. H Steel Beam and steel plate are two main types of steel import. Besides, steel billet, Steel sheet pile and Prestressing teel strand also contribute significant value to the import-turnover. However, the value was changeable depend on the market‟s situation (demand, price, competition) In 2008, Steel Beams accounts for 36.1% of the total import-turnover (VND 168,270 million in value). Particularly, H Steel Beam was VND 121,508 million which account for 26% of import-turnover. Steel billet and Steel sheet pile were around VND 50,000 Million, accounted for approximately 10% of the total import turnover. In 2009, import turnover of Steel Beams stood at VND 190,582 million. Particularly, the value of H Steel Beam was at VND 43,024 million, equals to 8.1% of total import turnover (down 75 percent) whereas the Steel plate soared to 1,235

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percent to VND 123,583 million. Steel billet climbed to VND 72,549 Million or 20 percent year-on-year increase whereas Steel sheet pile show the same performance as 2008. In 2010, the Steel Beams turnover declined approximately VND 50,000 Million in turnover due to the decrease of import contract for Steel sheet and Steel bar. The value of Steel sheet pile increased while the company did not have any steel billet import contract. There are two reasons for this situation:  The increase of output of high quality steel billet from domestic producer such as Hoa phat group, Pomina Steel Corporation… According to economic experts, there is high possibility that Vietnamese steel supplier can meet demand of domestic market in the future.  Vietnamese Government raised the import taxes on steel billet (3/2009) to 5%-8% to protect the domestic steel industry.  Few customers of CNT began having enough financial capacity to import materials by ourselves. For this reason, CNT lost many Steel billet, Steel bar and Steel sheet contracts. 2.1.7.2.3. Distribution of imports by country of origin Table 2.6- Distribution of imports by country of origin (Unit: Million VND) 2008 Value 153,819 China 22,190 Thailand 12,091 Malaysia 76,340 Japan 133,599 Korean 31,437 Taiwan 9,673 Singapore 12,091 Russia 14,510 French Total import turnover 465,751 Source: Accounting department. Country % 33.0 4.8 2.6 16.4 28.7 6.7 2.1 2.6 3.1 100 2009 Value 331,869 36,185 39,465 62,756 35,080 6,577 6,577 10,962 529,472 % 62.7 6.8 7.5 11.9 6.6 1.2 1.2 2.1 100 2010 Value 169,865 17,410 1,088 77,997 186,988 5,441 458,789 % 37.0 3.8 0.2 17.0 40.8 1.2 100

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China and Korean are the main import markets of CNT. The company imports some important materials from these markets, namely iron and steel, Steel sheet, Steel plate, Steel billet and H Steel Beam. The company also imports Steel sheet pile and Prestressing teel strand from Korean and Thailand. Generally, ASEAN are the main import market of CNT as the company can reduce the transportation cost and take advantages of many close relationships with partners. On the other hand. CNT also imports from French and Russia for some other special categories of building materials depending on the market‟s demand. In 2008, the company imported VND 153,819 million from China, accounted for 33 percent of total import turnover. Korean market stood at second rank with VND 133,599 Million, makes up 28.7% of the total. In 2009, the import turnover from China soared 100 percent to VND 331,869 million thanks to the increase of Steel plate and Steel billet demand. The import turnover from Korean decreased by 50 percent to VND 62,756 Million due to the decrease of H Steel Beam turnover. In 2010, the import turnover from all the market saw a sharp decrease. Particularly, the company did not import from Taiwan, Russia and French in that year. In conclusion, we can see obviously from the Market structure of import of CNT that it depends on the Commodity structure of import because of these following reasons:  The company mostly imports materials from traditional markets with familiar partners to take advantages of close distance and build up long-term cooperation. Also, commodities from new markets are difficult to sell than the ones from traditional markets due to unconfirmed quality standard.  The company just imports some special commodities from new markets when customers place orders or have demand.  Importing from new markets is riskier and needs doing lots of researches.

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2.1.8. Evaluating the position of CNT With its operating experience 30 years in construction field, CNT has a high position in the fields of material
trading and construction. In addition, CNT have maintained the close relationships with Construction Corporation No.1.. This brings many competitive advantages to the company. Material trading activities make up 90% of CNT‟s total revenue. In regard to Construction and real estate field sectors, although CNT have only 3 years experience, all of the projects that CNT have taken part in recently are very potential and promising. Construction field: CNT is the contractor of many big projects such as Tri An Hydro- power Factory, Thu Thiem Tunnel… One of the biggest strengths of the company is its abilities to carry out important infrastructure projects. Material trading field: With over 30 years of experience in material trading field, CNT have lots of good relationships with domestic and foreign clients. Therefore, the company is considered as a reliable partner in performing Material trading. The company ensures to provide the Right Product, At the Right Time, Right Place and at the Right Cost to the Customer. Moreover, CNT has close relationship with domestic and foreign manufacturers. In term of Material Trading, the company is also the first dealer and official distributor for many big domestic producers. With the wide system of branches, CNT has capacity to supply large volume construction materials for all customers. Especially, CNT is an important materials supplier for some of domestic producers. As a result, the company can exploit many preferential treatments from this mutual association. Investment (Real estate): Although CNT has just begun to invest in real estate projects in recent years, all the projects that CNT is investing are very potential and strategic such as Ha Tien Project, Green Pearl Project… In the future, these projects will enhance the position of the company on the market and bring benefit to the company and society.

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[Tang Huynh Yen Phuong]

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2.2. Risk analysis of transaction exposures at CNT 2.2.1.Overview of Steel import activities Table 2.7- The situation of signing and implementing Steel
import contract at CNT 2006-2010 Comparison Signed contract (A) Implemented contract (B) between (A) and (B) Year Total Total Total Volume Volume Quan. Quan. Value Quan. Value value (MT) (MT) (%) (USD) (USD) (%) 12 8,805,375 11,356 10 7,095,939 9,200 83% 78% 2006 2007 2008 2009 2010 11 9,198,181 13,329 13,567 10,802 10,294 11 9,198,181 13,329 12,937 10,402 10294 100% 100% 92% 90% 91% 94%

12 11,210,705 10 10 8,045,456 9,284,998

11 10,210,705 9 10 7,564,486 9,284,998

100% 100%

Source: Documents of import contracts in Sale department No2 The number of signed contracts and implemented contracts of Steel varies in recent years. It was influenced by many internal and external factors. Especially, the fluctuation of foreign exchange rate, and interest rate affected the company‟s situation during the economic crisis in 2008-2010. In 2006, the company signed approximately 12 Steel import contracts and there were 10 implemented contracts with 78% of the total value of signed contracts . The average value per contract is relatively small for the following reasons:  The company mostly decided to sign import contracts based on order-form of buyers (most of them are contruction company). The Board of Director only accepted an import proposal when the employees of Sale department had already signed a selling contract (for the total value or a certain value of import contracts) with domestic buyers.  The Payment method of most Steel import contract is irrevocable Letter of Credit, 100% payment at sight for the total value of the contract. At that

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[Tang Huynh Yen Phuong]

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time, the company‟s capital capacity and credit limit did not allow Sale employees to sign many high value contracts.  The human resources of the company were not strong enough to carry out high value contracts, and estimate demand of the market.  In the third quarter of 2006 (around June and July), the import price of Steel Beam increased by 10%. The company had signed 2 Steel import contracts in May but had not opened Letter of credit yet. Consequently, its partners decided to cancel the contracts. In 2007, the company signed 11 Steel import contracts and all of them were

implemented. The total value and volume of Steel import contract increased stably in that year. We also saw an increase in the average value per contract. There are many internal and external factors that affect the situation of signing and performing Steel import contract in that year:  There were many positive changes in the human resources of the company: The company widened import activities, improved human resources, recruited more sale employees. Some new members of board of directors were appointed in the end of 2006. These changes make good impacts on the operation of the company in that year.  The sale employees gradually improved their abilities of forecasting the market trend involving looking forward to changes, analyzing the market trend, and making secure and safe decisions. Although the price of steel fluctuated and increased a lot in that year, there were no canceled contracts in that year because the import employees tried to open Letter of Credit on time.  The increasing capital capacity (to 80 Billion VND on that year) helped the company to raise its credit limit at bank insitutions as well as reduce the L/C deposit. This leaded to an increasing in the total value of the import contracts as well as the average value of a import contract.

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[Tang Huynh Yen Phuong]

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 The company invested in many construction projects in that period. These
project helped the company gain reputation, establish more good and longterm relationship and attract more customers to the trading activities of the company. In 2008, the company signed approximately 12 Steel import contract. However, there are 1 canceled contract. The total volume of import contract was decrease from 13,329 MT to 12,937 MT whereas the total value was increase from 9,198,181 to 10,537,205. Only 91 percent of the total value of signed contract was implemented. There are several reason for these changes:  The price of import steel was relatively high in that year especially in the second and third quarter.  Vietnam joined WTO in 1/11/2007. The government paid more attention to domestic steel market and approved the master Plan on the development of Vietnam’s steel industry in the 2007-2015 period.

The steel market is more and more competitive.  Inventory level at the beggining of the year was relatively high so that the company had to reduce the import volume in that year.  The situation of real estate and contruction in that year was not good. In 2009, there are 10 signed contracts and 1 canceled contract in that year. The total value as well as total volume of performed contract decreased significantly due to several negative influences from the business environment:  The adverse impacts of economic depression in 2008, many foreign investment withdraw their investment. Many construction projects were delayed. Consequently, there was an decline in the demand for steel of many partners in that period of time.  The development of domestic steel industry and the increase of both USD price of import steel and foreign exchange rate made many customer tend to use more domestic steel in an effort to reduce cost in the economic depression period.

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[Tang Huynh Yen Phuong]

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 The fluctuation of foreign exchange market, the wide allowable trading band (up to 5% in 2009) made the company consider thoroughly before signing Steel import contracts.  The company concentrated more capital into construction projects.  Few customers of CNT began having enough financial capacity to import materials by ourselves. For this reason, CNT lost many Steel bar and Steel sheet contracts. In 2010, the company have implemented all of the signed contracts. However, the total value and volume of these contract were lower than in 2009 for several reasons.  The domestic steel market continued its growth impetus in this year. The industry‟s domestic production increased an estimated 18 percent. Vietnam reportedly produced 60 percent of steel and imported the remaining 40 percent. 2010 also marked a breakthrough for the Vietnamese steel industry, successfully producing the first zinc – plated corrugated iron sheets with output of 30 million tonnes, contributing to easing dependence on imports.  The sale employees were more competent in signing and carrying out import contracts.  The company lost some customers to competitors because they offered more competitive prices.  The world steel market suffered from many fluctuations in 2010. Therefore, the sale employees were quite careful in signing steel import contracts.  The company require more conditions on its sellers and buyers due to the fluctuation of foreign exchange market and interest rate. This leaded to a decline in Steel orders from many buyers.

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[Tang Huynh Yen Phuong]

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2.2.2. Analyze the procedure of Steel trade. Figure 2.5- The procedure of Steel trade.

Sign import contract.

Borrow US dollar Settle the payment

Sign Sale contract.

Receive VN dong. Pay off the loan.


Account receivable


Account payable with seller Cash paid to seller

Account payable with bank

Short cash
Cash paid to bank.

Signing rate Import proposal

Operating cycle

Paying rate

Usually CNT imports Steel which results in accounts payable in US dollar with sellers. It also sells import commodities to domestic buyers on credit, which results in accounts receivable in Vietnam dong. Cash, therefore, is not involved until the company collects accounts receivable. During this short cash period, the company must finance its operation by borrowing US dollar from banks which also results in accounts payable in US dollar with banks. Therefore, during the entire Operating cycle of Steel trade, the unexpected change in the foreign exchange rate will result in an extra VND amount of payable. In others word, the company suffers from transaction risk during the entire Operational cycle of Steel trade.

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[Tang Huynh Yen Phuong]

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According to Figure 2.5, the procedure of Steel trade can be summerized as the following steps: Step 1: Negotiate , sign, and implement Steel import contracts. Step 2: Borrow US dollar from banks to settle the import payments. Step 3: Contact potential customers. Negotiate, and sign sale contracts. Step 4: Receiving Vietnam dong payment from buyers, and paying off the loan. Step ❶: Negotiate , sign and implement Steel import contracts. The company enters into an import contract, and haves an account payable with the seller. After signing import contract, the company carrys out all the necessary procedures to implement the import contract including opening letter of credit and buying insurance. Also, the company drafts an import proposal to calculate the estimated profit of the import contract. The foreign exchange rate on the import proposal is the spot rate of the signing date. During this step, the company has an account payable in US dollar with the seller in the future. It does not settle the import payment until the commodities are delivered (after 30-45 days from the day of signing contract). Thus, all of the fluctuations of foreign exchange rate during this period causes changes to the estimated Vietnam dong value of account payable, and affects the estimated profit in the import proposal. In other words, the company begins to suffer from a transaction risk from this step.

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[Tang Huynh Yen Phuong]

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Table 2.8- Steel import proposal of CNT company. The seller: Hyundai Steel Company Date of signing import contract: 07th December 2009 Signing Exchange rate: 18,479VND/USD The buyer: Hoa Binh Construction and real estate Joint
Stock company Date of signing sale contract: 15th Janruary 2010. Delivery date: 3rd March, 2010 Commodity A. Cost of good sold Input price CFR HP Insurance premium 0.07% CIF price Import tax: 10% VAT of Import LC fee Estimated interest 1.5 months x 0.6%/month x 90%CIF price Direct fee: Container handling fee, customs charge, document inspection fee. Estimated cost of input Exchange rate: 18,479VND/USD B. Total value of output Estimated selling price (Without VAT) C. Profit (B-A) VAT: (B-A)/1.1 x 10% Profit per unit (B-A)/1.1 Total profit: 600MT Estimated rate of return: Profit per unit/ Selling price D. Other issue

H400 (No Hedging)
780 630.00 0.44 630.44 63.04 69.35 1.90 5.11 10.00 14,410,666.73 14,839,000.00 13,490,000.00 428,333.27 38,939.39 389,393.89 233,636,331.80 2.89%

Source: Documents of import contracts in Sale department No2

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[Tang Huynh Yen Phuong]

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According to Table 2.8, In the CNT‟s import proposal, the cost of good sold is converted into VND, and therefore the estimated profit is determined in VND. Determining estimated profit in Vietnam dong helps accountants, and board of directors estimate easily the inflow and outflow cash before signing sale contract. However, the company faces with higher transaction risk because the exchange rate on the import proposal may differ from the exchange rate on the date of selling to buyers. In other words, the amount of cost of good sold is a risk due to unanticipated changes in the exchange rate between Vietnam dong and the U.S. dollar. Other Steel import company such as Phu My dratfs its import proposal with the cost of good sold, and other cost determined in US Dollar; the estimated profit is also in US dollar (see Appendix 15).

With that import proposal, the company just converts the selling price in US dollar to Vietnam dong via the spot rate of the selling day when signing sale contracts to transfer all transaction risk from the date of signing import contract to the buyers. However, it is difficult for the board of management to estimate the real profit in Vietnam dong before signing sale contract. Step ❷: Borrow US dollar from banks to settle the import payments. The company mainly uses Documentary credit as a method of payment for the total value of steel import contract at sight. Therefore, in this step, if the relevant import documents do not have any discrepancies, CNT confirms the bank to settle the import payment. In this step, if the company uses its own captital to settle the payment or borrows money in Vietnam Dong to finance the import payment, it would not suffer from transaction risk for the rest of its Operating Cycle. However, because the company lacks of working capital, it must make a loan at the bank to finance the import payment, and repay it when receiving payments from buyers. In addition, the company prefers to borrow USD than to borrow dong as it can take advantages of the low USD interest rate. At that time, the company have an account payable with

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[Tang Huynh Yen Phuong]

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bank in US dollar that needs to be paid in the future. For this reason, the company is still suffer from the transaction risk. Step❸: Contact potential customers. Negotiate, sign and implement sale contracts. The employees of Sale departments contact potential customers to ask for their demands and inform them of various types of steels that the company have in it warehouse. For some familiar partners or other buyers, they can contact the company when they have demand of Steel. The sale employees gathers as much relevant information as possible to verify the credibility of buyers. Also, the company conducts market research about international steel price, domestic steel price, competitors‟ price list, movement of foreign exchange rate to offer a competitive price that can benefit for the company.

In this step, the company has an account receivable in VND in the future. In order to minimize the credit risks, the company requires some conditions:  For long-term and familiar partners with healthy financial situation, the company can sign sale contracts on a deferred payment terms about 30-45 days without requiring a letter of guarantee from a prestigious bank.  For other buyers, the company prefers an immediate payment of total amount after delivery, or an immidiate payment of a part of the contract and deferred payment after 30-45 days with a letter of guarantee from a prestigious bank. Letter Of Guarantee is refered to a type of contract issued by a bank on behalf of a customer who has entered a contract to purchase goods from a supplier, and promises to meet any financial obligations to the supplier in the event of default. Although these requirements help the company reduce the credit risks, it couldn‟t eliminate the transaction risk. The company still suffers from transaction risk during the account receivable period because it still has an outstanding account payable in US dollar with bank.

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[Tang Huynh Yen Phuong]

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*The account receivable period is the amount of time it takes the company to receive money after it has sold the import commodities. The longer account receivable period is, the higher transaction risk the company must suffer. Step❹: Receiving Vietnam dong payment from buyers, and paying off the loan. The company reiceives payment immediately or after a period of time depended on the terms of payment in the sale contract. If the company sell good with an immediate full payment after delivery, the company will receive VND to repay the loan a few days right after the date of signing sale contract. Normally, it receive payment 30-45 days after the date of signing sale contract in credit sale. When receiving money in bank account, CNT converts use money to buys USD with the spot exchange rate at that time (paying exchange rate) and spend that amount of money paying off the loan at the bank.  In the case of CNT company, it has a US dollar denominated payable (with the seller and banks), therefore, a change in value of the US Dollar during this period would alter the amount of the total VND to be paid in the future. Because the transaction exposure exists, the company must be alert to the fact that any change in the foreign exchange rate between the time the transaction is initiated and the time it is settled will most likely alter the original value of the transaction.

The transaction exposure gain or loss is the difference between the actual cash flow in Vndong in step 4 and the cash flow calculated in step 1 of the operation cycle. 2.2.3. Transaction exposures from 2006-2010 The transaction exposure of an import contract without hedging in this section is calculated via the formula: Transaction exposure= (Signing rate – Paying rate)* Total USD value of import contract Transaction

Signing Exchange rate: The spot exchange rate of the date when the company sign import contract and enter in an USD account payable with sellers.

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Paying Exchange rate: The Spot exchange rate of the date when the company actually settles its USD account payable to banks. Total USD value of import contract: CIF importing price (USD) * Quantity of a contract.

Transaction gain: Transaction exposure >0  Transaction loss: Transaction exposure

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