The Coca-Cola Company and the Impact of Derivatives
Introduction
The Coca-Cola Company is the marketer, distributor, and manufacturer of the non-alcoholic beverage concentrates as well as syrups in the entire world. It products had been sold in the whole world with marketing of non-alcoholic sparkling brands and manufacturing of syrups, concentrates, and beverage and having the canning operations and some of the fountain retailers for the finished beverages. The company also includes the markets, produce, and distributes juice products. It has also the exclusive master agreement and distribution to the Evian bottled water in Canada and in United States. For the financial 2007, the company’s syrups and concentrates for the beverage bearing of the trademark of the company or any trademark that can include the company’s trademark can had been accounted for about 53% of the of total concentrates sales (Reuters.com, 2008).
The coca-cola company is also considered to be the leading beverage company in the world. Parts of the company’s products include waters, fruit juices, coffees, and teas as well as the energy drinks. Being the largest beverages distribution system, the consumers for its products includes 200 countries which exceeds its rates of 1.5 billion savings every year. Including in the future plans of the company is the investment of $60 million in building the largest plastic-bottle-bottle plant of recycling and the support of US recycling. In its major goal is the recycling or reusing of 100 percent of the entire plastic bottles of the company in US alone (New York Job Source, 2008).
The company used the derivatives that serve as the financial instruments in order to alleviate the adverse fluctuation fro the company. These can help the interest rate as well as the foreign currency exchange rate, the other market risk, and the commodity prices. For the derivatives of the positions, it can be use to reduce the risk in neutralizing the economic exposure. The association of the hedging instrument and to the underlying exposure can decrease in the value instruments can generally offset by the reciprocal of changes in the value of the underlying exposure. In line with this, the Coca Cola Company is expected to have the general hedges which can be anticipated for 36 months prior, though, the primary instruments of derivatives can expire for 24 months or even less. This only indicates that the entire derivatives of the company are straightforward for over the counter liquid markets with the respective instruments (The Coca-Cola Company Corporate Website, 2008).
The Coca Cola Company and Its Derivatives
The derivatives are the financial instruments which are the value changes in response in the changes of the underlying variables. There are many uses of the financial derivatives and one of these is the reduction of its risk for the certain party. This implies that the wide range of the potential underlying assets can pay-off the alternatives which can lead to the great variety of derivatives contracts that are available in trading into the market. This also implies that the derivatives can also be based on the different asset type which includes the equities, the stocks, commodities, exchange rate, interest rate or even the indexes. Transferring the risk through taking the opposite position for the underlying asset is the primary use of derivatives (Anson, M, n.d., p.18).
The company used the derivatives for the financial instruments in further reducing the net exposure to the currency fluctuation. The company also uses the derivatives in controlling the cost of vast quantities of sugar in the maintenance of the needs in making the syrup. This implies that the steady and low prices for the staples like the bread, the coffee, and the vegetable oil are oil been done using the derivatives. In this manner, the company uses the derivatives in hedging and fro the protection of its profits. This can also be the call option for the Coca-Cola Company which is derivatives in the security for obtaining the value of the shares of the Coca Cola which can be purchased into the call option. Taking the example of the year 2007, that generated 74 percent of the net operating revenues which are taken from the operations from outside the United States which weakens the particular currency which can have the possibility to offset its strengths to the other currencies in the entire time. The company had entered in the purchase currency options and to then forward exchange contracts in the collars of the hedge of the certain portions which are predicted cash flows and denominated in the foreign currencies. Managing the business risks for the company can determine the future of the company as well. This means that if risks are not considered in the annual report, then, they are covered in the quarterly reports. Since, the company had experienced certain business dilemmas and the earnings can set back which can be more difficult to achieve, the company derives its 75% for its profits outside the North America. The operation of the company in the Latin America and to Asia can carry the political and economic risk whereas the foreign currency can fluctuate and can carry the risk. Thus, the dropping of the countries’ respective currency can lower the earnings into the multinational firms. Therefore, the managers of Coca Cola Company are using the process of the hedging technique in order as the use of derivatives in order to reduce the risk though is no assurance that it will be successful. The risk that the company had faced was the weakening of the future demands and part of it was depends of je company’s promotions, advertising, and marketing. Nevertheless, the company has the ability in controlling the trends for the global economy, the devaluation, and fluctuation of the currency, as well as political upheavals, natural disasters, bad weather, social unrest and the schizophrenic stock market (Price, 2000, p. 19).
The company also entered into the forward exchange contracts so that it can have the impact on earnings that relates in the fluctuation of the exchange rate in the definite monetary liabilities and asset. In order to neutralize the net investments in the international operations, the company had entered in the forward exchange contracts. In relation to the interest rate, the company had monitored the mix of the variable-rate debt and the fixed rate and t the mix of the short term debt to its long term debt. In connection to this, the company had entered to the agreement for the swap of interest rate in managing the mix of the fixed-rate as well as the variable-rate debt. In the value-at risk, the company is monitoring its exposure to its financial market risks with the aide of several system of objective measurement which also includes the model of value at risk. The company’s calculation of value-at-risk use the historical model in estimating the potential future losses in the fair value of the other financial instruments which includes derivatives which can have the possibility in occurring to the result of the adverse movements to the foreign currency as well as the interest rates. In this manner, the company is not considering the potential impact of the favorable movement into the calculation of interest rate and foreign currency. Upon the examination of historical weekly returns for the past years, the value at risk can be calculated. This means that the average value at risk signifies the simple average for the quarterly amounts for the past year. Resulting to the foreign currency, the calculation of the value-at-risk, the estimation of fair values had recognized with the 95 percent confidence that the fair values of the company’s financial instruments and currency derivatives for the week can decline by not greater than $19million and $14 million and $9 million for the year 2007, 2006, and 2005 respectively. In accordance to the interest rate of the calculation of value-at-risk, the estimated 95 percent confidence can increase to the net interest expense because of the adverse move in the average year of 2007 which shows that the interest rates for one-week period cannot have the material impact to its consolidated financial statement (The Coca-Cola Company Corporate Website, 2008).
The Objectives of the Activities of Coca Cola Company Derivatives
Since the derivative is any security which can derive its value from another asset or security. Therefore, the company is using derivatives in order to hide the risk, manipulate earnings, and to evade the regulations. The coca cola company is using the derivatives in order to control the cost of the vast quantities for the sugar that can be needed in making syrup. Given that the company is developing the significant strategies in managing it foreign exchanges as well as alleviating the risk because of fluctuation, then, it uses the derivatives for hedging in protecting its profits. For the past years, there is also increase in the investment in cross-border portfolio. Thus, the currency hedging can protect the profit of Coca Cola Company. In accordance to the president of the Coca-Cola Company, they use the derivatives and hedges in protection for the currency fluctuation. Thus, the firm can benefit on this portfolio due to the dealings of more than 200 currencies and dealing to the lower currencies cannot take effect on the portfolio. The main objective of the company fro using the derivatives and hedging program was the elimination of the risk in the earnings for the down fall of the currency and the increase of the protection for hedging horizon (McInish, 2000, p. 413). The company is using the contracts of forward exchange and the swap contracts as well as purchasing options in hedging both the firmly anticipated and committed transactions as net investment and appropriate in the world operations. The financial instruments of the company are straight forward with having the liquid markets. The company is also using the liquid spot, option, forward, and swap contracts. The company is not entering into the financial instruments for the trading purpose only, rather, its financial positions are using in the reduction of risk through neutralizing to the economic exposure. This policy can mitigate some of the risks which include the change in the interest rate, currency, and to the other market factors as commodities. In this strategy, the hedging for the transactions of gains and losses can be offset by the underlying exposures that had being hedged to the offsets of gains and losses (Lycos, 2008).
The Other Alternative Strategies in Achieving its Goals
The other strategies that the company can use were the effect of Fiscal Policy which can have the four components as the growth of the business, the employment, inflation, and the business cycle. For the employment, the company needs to conduct the ability and significant strategies in global scale and thought to the human resources. This signifies that the decision making is not only for the management but for the employees as well. These improvements can also give progress and success to the structures and growth of the company as the dealing to the people today. The manifesto for the growth is also the strategy of company in its overall vision and includes the factors as the portfolio, the profit, people, and planet. The growth of the company needs to prioritize as well which is includes the monitoring of the sales and revenues. The increase in the sales and to the international growth must be backed up by the great marketing technique and strategic development plan. The company’s business cycle was also a significant alternative strategy is developing and achieving their goal which was caused by the market trends. Thus, the awareness on the product cycle for the items will intend in selling it to the market to make it the leader in the market. In order to be internationally recognized, if needed, the packaging changes must be needed and affects by the industry and sales positioning. The alternative ways also in order to meet the company’s objectives is the adjustments regarding inflations in world market. Then, the increase for the prices was the way for the company to overcome inflation. Thus, the increase in the unit cost for the beverage can generate the exact cash flows and can affect the capital resources, liquidity, cash flows, and the entire financial position of the company. Thus, the competition to the industry market globally is significant and can affect its distribution, production and prices that pass through the customers (McKay and Cordeiro, 2008).
In optimizing its cost of capital, the company can acquire the components for capitalizing the shareowners value. The debt financing is also strategic for the company which is based on the cash flow, total capital of debt, and percentage as in can be use in lowering the cost of capital and increase the return equity of shareowners. The strong capital positioning can have the easy access in the financial market for the company in general and can raised funds effectively. This can lower the cost of borrowings as well as the whole debt management for polices and the conjunction for the borrowing (Lycos, 2008).
Effect of Derivatives to the Coca Cola Company
The Coca Cola Company was the vulnerable in the interest rate and to the floating rate. Based on the analysis made to the use of the hedging tools of the company, there is a huge impact for the derivatives to the company. These financial derivatives gave differences to the financial position of the company as well as the improvements in its interest rate which are the financial institutions for the company. The company then is not affected to the nonperformance for these parties as the credit loss. The target borrowings of the company were 40%-60% yet expected to be outside this range at the given time. In order to relate the idea regarding the variable rate debt, and suppose that there are no financial structures for the company, then, there is an increase for the interest rate for the company. This can have the effect by the calculation of the interest rate with regards to the variable rate debt right after the consideration of the hedging activities. This increase was because of the varied interest rate, floating debt, and the derivatives of the financial instruments (Coca Cola Corporate Website, 2008).
The Monitoring and Governance of the Derivative Positions of Coca-Cola Company
In maintenance and monitoring for the derivatives of the company, it is considers prudently the financials that are based on the cash flow, to the interest coverage, and to the percentage of debt. In the lowering the debt financing and increase of the return, the rating agencies are the responsible in the computation of the coverage ratio and the additional interest expenses for the sum capitalized interest and the calculation of ratio that is why the hedging of the company was still considered part of the responsibilities.
The company has also the ability in monitoring the coverage ration for the ratio assessment into the credit rating. Thus, it only signifies that the interest coverage for the company was the assessment of the debt rating. Then, the basis only signifies that the strong capital position and global presence can give the access into the key financial markets of entire world which can enable for the company in rising to the low yet effective cost. The company needs to monitor its financial measures for the conjunction to the mix of fixed-rate and to the variable-rate debt as well as the financial risks and other business. In the previous years, these measurements can have positive impact on the effectiveness and improvement into the business results and to the capital management strategy of the company (The Coca Cola Company Annual Report).
Ex-Post Outcomes of the Derivatives of Coca Cola
The implementation of the derivatives in the entire business operations of the company made the significant impact it is growth and development. In relation to this, the company can manage the majority of the exposure of the foreign currency in the consolidated basis. The effect occurs in the weakening of the specific currency while strengthening the other currencies because of the recorded 74 percent of the net operating revenues. This only reflects that using the derivative can be great way hedging the currency risk in the specific market. In the process of monitoring for the market risk of the company, through the aide of the measurement systems, it can generate the adverse movement of the foreign currency. Te determination of the calculation of the currency risk of the company can have the favorable impact to its movements in its interest rates. Into the foreign currency risk, there had been lowering of its value for about $20 and went down in the year 2007-2005 for $9 which is more risky as compared to the past years because of the value at risk. The hedging technique of the company was the sufficient covering up of the required risk for the denomination of the foreign currencies. Additionally, the use exchange ate contract will have the impact as well to its earnings which needs more resources for the hedging instruments as analyze by the company in neutralizing the fluctuation of the exchange rate for the single monetary assets or liabilities. Thus, the perseverance of the company in the international growth had been entered to the contract for the foreign exchange which can also be hedging technique and the interest rate of the company can manage the mix of the fixed-rate as well as the variable rate because of entering into the swaps. This implies that the company can then conquer the risk for the interest rate because of its ability to monitor the variable rate mix and debt and the fixed-rate.
Conclusion
Being the largest distributor, manufacturer and distributor of non-alcoholic beverages syrups and concentrates in the whole world, the Coca-Cola Company needs to use the derivatives in order to increase the cost of capital and pursuing the objective for maximization of shareholders value. Aside form that, this financial derivatives are the primary instruments for the company’s reduction of exposure over the harmful fluctuation of commodity market risks and prices. These derivatives can be use by the company for reducing the risks and neutralizing the underlying economic exposure. Nevertheless, these derivatives can have the huge impact in the market risk of the company that alleviated the average value in foreign exchange and to the interest rate. This implies that the company has the strong foundation and management strategies in surviving for this kind of risks.
Bibliography
Price, R 2000, Lessons From the Legend of Wall Street, Kaplan Publishing, United States.
McInish, 2000, Capital Markets: A Global Perspective, Balckwell Publishing, United Kingdom.
McKay, B and Cordeiro, A 2008, “Coke Gets Lift From Abroad Amid US Weakness” Wall Street Journal, Eastern Edition.
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Anson, M n.d., Accounting and Tax Rules for Derivatives,
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