Weekly Puzzle #1: Violating Corporate Finance Core Principles

The Set up

The last few weeks have been tumultuous ones for the currency markets, as the dollar has surged against other currencies, the Swiss Franc has been freed from its euro peg and the Australian & Canadian dollars have dropped as oil prices have decline.  In a market that has become used to stable exchange rates, the volatility has come as a shock and it has also brought to the surface the bad practices that individuals, investors and companies have adopted due to greed, laziness or pure ignorance (or a combination of all three).

The stories

The Swiss Franc's surge was the most shocking of the currency movements because the assumption among many was the Swiss Central Bank would do whatever it needed to do to preserve its pegged value, relative to the Euro. Here is the story on the day that the Swiss Central Bank decided to be unpredictable: When the franc surged by 30% in one day, the fallout began and the stories below illustrate how widely the impact was felt.

  1. What's so smart about the smart money?: I have never believed that hedge fund managers are somehow inherently smarter than the rest of us. This story is about one hedge fund (Everest Capital), but it is really a broader one about the hubris of some hedge fund honchos and the emptiness of their strategies. The manager of Everest Capital Hedge fund, Marko Dimitrijevic, made a bet that the Swiss franc would decline though it unclear what fundamentals led to this judgment (or whether fundamentals were even considered).  The scary news in the second-to-last paragraph,  where we are told that this fund has $2.2 billion in assets still.
  2. Investor hubris?: If you think hedge funds are the only institutions that have the hubris to bet on things that they don't control and cannot predict, this story shows you that it is an all-too human tendency. The broker that failed, FXCM, allowed individual investors to leveraged bets on currency movements. I especially like the story of Rick Smallwood, living in Belize, betting on the Swiss franc.
  3. What's with French municipalities? The first paragraph provides the essence of this story: French municipal borrowers are seeing the cost of billions of euros in Swiss franc-linked debt spiral dangerously higher, forcing the state to consider lending them a helping hand.
  4. The Polish homeowner's sad story: his story in the New York Times is about Polish homeowners who have taken homeowner loans in Swiss Francs to buy their houses in Poland and how the surge in the Swiss Franc is putting them at risk.
  5. Swiss Commodity Traders devastated: In the first line of the story, you get to the core of the problem. Swiss commodity traders generate their revenues in US dollars (since commodity markets are dollar-based) but their expenses (salaries and other costs) are all in Swiss Francs. The rest of the story writes itself.
  6. Swiss companies discover that they are not Swiss: This story looks at Swiss companies like Swatch and Richemont that get 80-90% of their revenues from outside Switzerland that have borrowed predominantly or only in Swiss Francs.


Questions/ discussion issues

  1. The first two stories are about speculators in the Swiss Franc who were burnt by the rise in the currency. What lessons, if any, can you draw from them for investing?
  2. The next four stories are about mismatches in currencies between cash inflows and outflows, covering individuals, municipalities, traders and corporations. What lessons, if any, can you draw from these stories?
  3. What general corporate finance lessons can you draw for individuals, investors and businesses?