A case study written by Professor Ian Giddy
Paretti Textiles, SpA, located in Milan, Italy, is a wholly owned subsidiary of Conti Industries, an industrial fabrics manufacturer based in Darien, Connecticut, USA. In late 1993 the Treasurer of Conti, Mr. Richard Baden, was looking at the currency exposure of the Italian subsidiary. In previous years, Conti had incurred translation losses resulting from the depreciation of the Italian lira, for which Baden had been criticized. Although Conti was profitable, this had not always been the case, and the company could not afford further currency losses. (See Exhibits I and II.) Baden was determined to put in place an economically sound, and defensible, hedging strategy for the forthcoming year.
Paretti specialized in the production and marketing of printing blankets, a specialized fabric used in newspaper and magazine printing. In 1992 it had $34 million sales in Europe and $6 million in the USA. Its sales were denominated as follows: USD 16.8%, DEM 15.6%, ILR 14.5%, FFR 14.3% and UK£ 13.9%. All production was in Italy. Paretti's main competition was a subsidiary of Merida, the US textiles company, and a Japanese company. However in Europe, Paretti had exclusive relationships with its distributors in Italy, Germany, France and the United Kingdom. In exchange for this exclusivity, Paretti never raised prices to its customers once price lists were printed at the beginning of each year.
Conti did not have a consistent foreign-exchange hedging policy. However, in August 1993, as the European Monetary System appeared to be undergoing severe strains, Baden had decided to hedge some of the anticipated earnings from Paretti for 1994. Accordingly, he sold $1.5 million equivalent of Italian lire for 9 months forward delivery.
Under US accounting rules, Conti used the local currency of the country
of operation as the functional currency for purposes of translating Paretti's
local currency asset and liability accounts at currency exchange rates
into Conti's reporting currency, the US dollar. The resulting translation
adjustments were accumulated as a separate component of shareholders' equity
(see Exhibit III). Gains and losses resulting from translating asset and
liability accounts that were denominated in currencies other than the functional
currency were included in income.
Paretti SpA Exhibits
Exhibit I. Income Statement of Conti Industries.