Problem Probl em 10.2 Siam Cement Cement
Sia! .e!ent, the angkok*based ce!ent !anu$acturer, su$$ered su$$ered enor!ous losses with the co!ing o$ the t he Asian crisis in 19972 (he co!pan# had been pursuing a ver# aggressive aggressive growth strateg# in the !id*1993s, taking on !assive "uantities o$ $oreign currenc# deno!inated debt 4pri!aril# U2S2 dollars52 6hen the (hai baht 45was devalued $ro! its pegged rate o$ 823/ in Jul# 1997, Sia!:s interest pa#!ents alone were over 933 !illion on its i ts outstanding dollar debt 4with an average interest rate o$ 2;3< on its U2S2 dollar debt at that ti!e52 Assu!ing Sia! .e!ent took out 83 !illion in debt in June 1997 at 2;3< interest, and had to repa# it in one #ear when the spot exchange rate had stabili=ed at ;23/, what was the $oreign exchange loss incurred on the transaction>
Assumptions US dollar debt taken out in June 1997 US dollar borrowing rate on debt Initial spot exchange rate, baht/dollar, June 1997 Average spot exchange rate, baht/dollar, June 199
Value 50,000,000 8.400% 25.00 42.00
Sce(ule( &epa'ment) &epa#!ent o$ US dollar debt% 'rincipal &epa#!ent o$ US dollar debt% Interest (otal repa#!ent
$ $
50,000,000 4,200,000 54,200,000
)xchange rate at ti!e o$ repa#!ent, baht/dollar (otal repa#!ent in (hai baht (otal proceeds $ro! loan, up*$ront, in (hai baht +et interest to be paid, in (hai baht
Actual &epa'ment) &epa#!ent o$ US dollar debt% 'rincipal &epa#!ent o$ US dollar debt% Interest (otal repa#!ent
$ $
)xchange rate at ti!e o$ repa#!ent, baht/dollar (otal repa#!ent in (hai baht ess what Sia! had )-').() or S.0)U) S. 0)U) to be repaid A!ount o$ $oreign exchange loss on debt
$
Calculation of orei!n "#an!e oss on &epa'ment of oan
At the ti!e the loan was ac"uired, the scheduled repa#!ent o$ dollar and baht a!ounts would have been as $ollows%
25.00 1,*55,000,000 1,250,000,000 105,000,000
50,000,000 4,200,000 54,200,000 42.00 2,2+,400,000 -1,*55,000,000 /21,400,000
Problem 10.1 P n(ia 'roctor and Ba!ble:s a$$iliate in India, ' B India, procures !uch o$ its toiletries product line $ro! a Japanese co!pan#2 ecause o$ the shortage o$ working capital in India, pa#!ent ter!s b# Indian i!porters are t#picall# 13 da#s or longer2 ' B India wishes to hedge a 28 !illion Japanese #en pa#able2 Although options are not available on the Indian rupee 4&s5, $orward rates are available against the #en2 Additionall#, a co!!on practice in India is $or co!panies like ' B India to work w ith a currenc# agent who will, in this case, lock in the current spot exchange rate in exchange $or a ;28< $ee2 U sing the $ollowing exchange rate and interest rate data, reco!!end a hedging strateg#2 Assumptions 13*da# account pa#able, Japanese #en 4?5 Spot rate 4?/5 Spot rate, rupees/dollar 4&s/5 I!plied 4calculated5 spot rate 4?/&s5 13*da# $orward rate 4?/&s5 )xpected spot rate in 13 da#s 4?/&s5 13*da# Indian rupee investing rate 13*da# Japanese #en investing rate .urrenc# agent@s exchange rate $ee ' B India@s cost o$ capital
e(!in! Alternati6es
Values 8,500,000 120.0 4+.+5 2.525+ 2.4000 2.000 8.000% 1.500% 4.850% 12.00% Values
-120.0 3 4+.+5
Spot &ate -&p3$
&is Assessment
1. &emain 7nco6ere(, settlin! A3P in 180 (a's at spot rate
I$ spot rate in 13 da#s is sa!e as current spot
*,*5,44.*4
2.525+
&isk#
I$ spot rate in 13 da#s is sa!e as $orward rate
*,541,.+
2.4000
&isk#
I$ spot rate in 13 da#s is expected spot rate
*,2/,2*0.++
2.000
&isk#
*,541,.+
2.4000
.ertain
2. u' 9apanese 'en for:ar( 180 (a's
Settle!ent a!ount at $orward rate 4&s5
Inv rate .C. +o2 o$ da#s Spot rate
*. ;one' ;aret e(!e
'rincipal A/' 4?5 discount $actor $or #en investing rate $or 13 da#s 'rincipal needed to !eet A/' in 13 da#s 4?5
8,500,000.00 0.//2 8,4*,+24.5+
.urrent spot rate 4?/&s5 Indian rupee, current a!ount 4&s5 'B India@s 6A.. carr#*$orward $actor $or 13 da#s Future value o$ !o ne# !arket hedge 4&s5
2.525+ *,*40,411.2 1.000 *,540,8*5./4
'rincipal A/' 4?5 .urrent spot rate 4?/&s5 .urrent A/' 4&s5
8,500,000.00 2.525+ *,*5,44.*4
'lus agent@s $ee 4;283<5 ' B India@s 6A.. carr#*$orwad $actor $or 1 3 da#s on $ee (otal $uture value o$ agent@s $ee 4&s5
1*,225.02 1.000 1+*,018.52
(otal A/', $uture value, A/' G $ee 4&s5
*,5*8,482.8+
Ap iscount $actor 'rincial needed 'rincipal )"uivalent .C. total A' .ertain
4. n(ian Currenc' A!ent e(!e
"6aluation of Alternati6es
(he currenc# agent is the lowest total cost, in .)&(AI+ $uture rupee value, o $ all certain alternatives2
,833,333233 3299888D1D ;DE7;28E8 DD;3;112E38 123E D8;3D829DE1
1283< 1< 13 2887
<*,000,000.00 $1.+20 $1.+550 .000% 8.000% 8.000% 14.000% $1.+5 1.500% $1.+1 1.000% 12.000% $1.+850
.ertain
Problem 10.* io=ron ;e(ical, nc. rent ush, .FC o$ a !edical device !anu$acturer, io(ron Hedical, Inc2, was approached b# a Japanese custo!er, +u!ata, with a proposal to pa# cash 4in #en5 $or its t#pical orders o$ ?1,833,333 ever# other !onth i$ it were given a ;28< discount2 +u!ata@s current ter!s are D3 da#s with no discounts2 Using the $ollowing "uotes and esti!ated cost o$ capital $or +u!ata, ush will co!pare the proposal with covering #en pa#!ents with $orward contracts2 Spot rate, ¥/ D3*da# $orward rate, ¥/ 93*da# $orward rate, ¥/ 13*da# $orward rate, ¥/ +u!ata@s 6A.. io(ron Hedical@s 6A..
?1112;3/ ?111233/ ?1132;3/ ?13923/ 283< 9233<
0ow !uch in U2S2 dollars will io(ron Hedical receive 15 with the discount and 5 with no discount but $ull# covered with a $orward contract> Assumptions io(ron@s D3*da# account receivable, Japanese #en Spot rate, ¥/ D3*da# $orward rate, ¥/ 93*da# $orward rate, ¥/ 13*da# $orward rate, ¥/ +u!ata@s 6A.. io(ron Hedical@s 6A.. esired discount on purchase price b# +u!ata
Values 12,500,000 111.40 111.00 110.40 10/.20 8.850% /.200% 4.500%
rent us soul( compare t:o basic alternati6es, bot of :ic eliminate te currenc' ris. 1. Allo: te (iscount an( recei6e pa'ment in 9apanese 'en in cas
Account recievable 4#en5 iscount $or cash pa#!ent up*$ront 4;2833<5 A!ount paid in cash net o$ discount
12,500,000 -52,500 11,/*+,500
.urrent spot rate A!ount received in U2S2 dollars b# Seattle Scienti$ic
$
111.40 10+,158.8/
Account receivable 4#en5 D3*da# $orward rate A!ount received in cash in dollars, in D3 da#s
$
12,500,000 111.00 112,12.1
iscount $actor $or D3 da#s Seattle@s 6A.. 'resent value o$ dollar cash received
0.//24 111,+55.82
2. >ot offer an' (iscounts for earl' pa'ment an( co6er e#posure :it for:ar(s
$
rent ush should politel# decline +u!ata@s o$$er to pa# cash in exchange $or the re"uested discount2
Problem 10.5 Vi?or Parmaceuticals Ki=or 'har!aceuticals, a U2S2*based !ultinational phar!aceutical co!pan#, is evaluating an export sale o$ its cholesterol*reduction drug with a prospective Indonesian distributor2 (he purchase would be $or 1,E83 !illion Indonesian rupiah 4&p5, which at the current spot exchange rate o$ &p9,;83/, translates into nearl# 178,3332 Although not a big sale b# co!pan# standards, co!pan# polic# dictates that sales !ust be settled $or at least a !ini!u! gross !argin, in this case, a cash s ettle!ent o$ 1E,3332 (he current 93*da# $orward rate is &p9,983/2 Although this rate appeared unattractive, Ki=or had to contact several !aLor banks be$ore even $inding a $orward "uote on the rupiah2 (he consensus o$ currenc# $orecasters at the !o!ent, however, is that the rupiah will hold relativel# stead#, possibl# $alling to &p9,;33/ over the co!ing 93 to 13 da#s2 Anal#=e the prospective sale and !ake a hedging reco!!endation2 Assumptions &eceivable due in D !onths, in Indonesian rupiah 4&p5 Spot rate 4&p/5 )xpected spot rate in 93 da#s 4&p/5 D*!onth $orward rate 4&p/5 Hini!u! dollar a!ount acceptable at settle!ent
Alternati6es
Values &p1,50,000,000 /,450 /,400 /,/50 $18,000.00
Values
At Spot $1+4,0*.1+
&is Assessment
1. &emain 7nco6ere(.
Settle A/& in 93 da#s at current spot rate2 I$ spot rate in 93 da#s is sa!e as current 4&p 1,E83,333,333 / &p 9,;83/5
$1+4,0*.1+
&isk#
I$ spot rate in 93 da#s is &p9,;33/ 4&p 1,E83,333,333 / &p 9,;33/5
$1+5,5*1./1
&isk#
I$ spot rate in 93 da#s is &p9,33/ 4&p 1,E83,333,333 / &p 9,983/5
$15,82/.15
&isk#
A/& sold $orward 93 da#s
$15,82/.15
.ertain
.ost o$ cover is the $orward discount on &p
@20.1%
2. Sell n(onesian rupia for:ar(.
Anal'sis
(he Indonesian rupiah has been highl# volatile in recent #ears2 (his !eans that during the 93*da# period, an# variet# o$ econo!ic or political or social events could lead to an upward bounce in the exchange rate, reducing the dollar proceeds at settle!ent to an unacceptable level2 Un$ortunatel#, the $orward contract does not result in dollar proceeds which !eet the !ini!u! !argin2 (he cost o$ $orward cover, 321<, is indicative o$ the arti$icial interest rates used b# so!e $inancial institutions while pricing derivatives in e!erging, illi"uid, and volatile !arkets2 In the end, Ki=or will have to decide whether !aking the sale into this speci$ic !arket is worth breaking a co!pan# polic# on !ini!u! proceeds 4$orward cover5 or taking signi$icant currenc# risk b# not using a $orward cover2
Problem 10.4 "mbraer of ra?il
)!braer o$ ra=il is one o$ the two leading global !anu$acturers o$ regional Lets 4o!bardier o$ .anada is the other52 &egional Lets are s!aller than the traditional civilian airliners produced b# Airbus and oeing, seating between 83 and 133 people on average2 )!braer has concluded an agree!ent with a regional U2S2 airline to produce and deliver $our aircra$t one #ear $ro! now $or 3 !illion2 Although )!braer will be paid in U2S2 dollars, it also possesses a currenc# expo sure o$ inputs N it !ust pa# $oreign suppliers 3 !illion $or inputs one #ear $ro! now 4but the# will be delivering the sub*co!ponents throughout the #ear52 (he current spot rate on the ra=ilian real 4&5 is &12;3/, but it has been steadil# appreciating against the U2S2 dollar over the past three #ears2 Forward contracts are di$$icult to ac"uire and considered expensive2 .itibank rasil has not explicitl# provided )!braer a $orward rate "uote, but has stated that it will probabl# be pricing a $orward o$$ the current ;233< U2S2 dollar eurocurrenc# rate and the 13283< ra=ilian govern!ent deposit note2
Assumptions &eceivable due in one #ear, US dollars 'a#able due in one #ear, US dollars Spot rate, reais per dollar 4&/5 Cne*#ear US dollar eurocurrenc# interest rate Cne*#ear ra=ilian govt deposit note I!plied one #ear $orward rate M spot x 4 1 G i& 5 / 4 1 G i 5
Anal'sis
Values $80,000,000 $20,000,000 1.8240 4.00% 10.50% 1./*80
Values
&is Assessment
>et e#posure at time of cas settlements)
Cne #ear A/& due Cne #ear A/' due +et exposure
$80,000,000 -$20,000,000 $0,000,000
.ertain
(his is a net long position, !eaning, )!braer will be receiving US dollars on net2 Biven the histor# o$ the ra=ilian reais, that it has traditionall# su$$ered $ro! rapid depreciation and occasional devaluation, a net long position in dollars b# !ost ra=ilian co!panies is considered a ver# good thing2
Cas settlement of te net position)
ra=ilian reais in one #ear at current spot rate
&$ 10/,440,000.00
&isk#
ra=ilian reais in one #ear at one #ear $orward rate
&$ 11,280,000.00
.ertain
In this case, however, because the reais is selling $orward at a considerable discount, the net long position ** i$ sold $orward ** #ields considerabl# !ore reais than the current spot rate2 It should also be noted, however, that i$ the reais were to $all considerabl# over the co!ing #ear, b# re!aining unhedged )! braer would enLo# greater reais returns2
111
Problem 10.+ obcat Compan'
obcat .o!pan#, U2S2*based !anu$acturer o$ industrial e"uip!ent, Lust purchased a Oorean co!pan# that produces plastic nuts and bolts $or heav# e"uip!ent2 (he purchase price was 6on7,833 !illion2 6on1,333 !illion has alread# been paid, and the re!aining 6onE,833 !illion is due in six !onths2 (he current spot rate is 6on1,113/, and the E*!onth $orward rate is 6on1,178/2 (he six* !onth Oorean won interest rate is 1E< per annu!, the six*!onth US dollar rate is ;< per annu!2 obcat can invest at these i nterest rates, or borrow at < per annu! above those rates2 A six*!onth call option on won w ith a 133/ strike rate has a D23< pre!iu!, while the six*!onth put option at the sa!e strike rate has a 2;< pre!iu!2
obcat can invest at the rates given above, or borrow at < per annu! above those rates2 obcat@s weighted average cost o$ capital is 13<2 .o!pare alternate wa#s that obcat !ight deal with its $oreign exchange exposure2 6hat do #ou reco!!end and wh#> Assumptions 'urchase price o$ Oorean !anu$acturer, in Oorean won ess initial pa#!ent, in Oorean won +et settle!ent needed, in Oorean won, in six !onths .urrent spot rate 46on/5 Six !onth $orward rate 46on/5 obcat@s cost o$ capital 46A..5
Values +,500,000,000 -1,000,000,000 ,500,000,000 1,110 1,1+5 10.00%
Cptions on Oorean won% Strike price, won Cption pre!iu! 4percent5
'rincipal won Spot won/ Frwd Oorean Int rate US rate Oorean borrow rate US borrow rate wacc
E833333333 1113 1178 1E< ;< 1< E< 13<
Cptions Strike rate .all 're!iu! 'ut 're!iu!
Unhedged
8888828E
Uncertain
Frwd
88D191;29;
.ertain
329898989 E3181819 e"uivalent 8;32788 1238 8E9D19D219D
.ertain
Hone# !arket
Call ption 1,200.00 *.000%
Put ption 1,200.00 2.400%
7nite( States 4.000% 2.000% .000%
Borea 1.000% 2.000% 18.000%
Values
Certaint'
$
,500,000,000 1,110 5,855,855.8
Uncertain2
$
,500,000,000 1,1+5 5,5*1,/14.8/
Uncertain2
$
,500,000,000 1,1+5.00 5,5*1,/14.8/
.ertain2
$
,500,000,000 1.080 ,018,518,518.52 1,110.00 5,422,088.+ 1.050 5,/*,1/*.1/
.ertain2
$
f e#ercise( ,500,000,000 1,110.00 *.000% 1+5,+5.8
1333 1333 933 993
Cptions Harket .all
Six*!onth invest!ent 4not borrowing5 interest rate 4per annu!5 orrowing pre!iu! o$ 2333< Six*!onth borrowing rate 4per annu!5 &is ;ana!ement Alternati6es 1. &emain unco6ere(, main! te :on pa'ment in monts at te spot rate in effect at tat (ate Account pa#able 4won5 'ossible spot rate in six !onths% current spot rate 4won/5 .ost o$ settle!ent in six !onths 4US5
Account pa#able 4won5 'ossible spot rate in six !onths% $orward rate 4won/5 .ost o$ settle!ent in six !onths 4US5
2. or:ar( maret e(!e. u' :on for:ar( si# monts
Account pa#able 4won5 Forward rate 4won/5 .ost o$ settle!ent in six !onths 4US5
*. ;one' maret e(!e. "#can!e (ollars for :on no:, in6est for si# monts.
Account pa#able 4won5 iscount $actor at the won interest rate $or E !onths 6on needed now 4pa#able/discount $actor5 .urrent spot rate 4won/5 US dollars needed now .arr# $orward rate $or six !onths 46A..5 US dollar cost, in six !onths, o$ settle!ent
$
4. Call option e(!e. ->ee( to bu' :on call on :on
Cption principal .urrent spot rate 4won/5 're!iu! cost o$ option 4<5 Cption pre!iu! 4principal/spot rate x < p!5 I$ option exercised/not exercised, dollar cost o$ won 're!iu! carried $orward six !onths 4p! x 1218, 6A..5 (otal net cost o$ call option hedge i$ exercised
$ $
5,41,.+ 184,45/.45/ 5,01,12.1* Haxi!u!2
133 D< 2;3<
f not e#ercise( 1,*00.00
$ $
5,000,000.00 184,45/.4 5,184,45/.4
(he $orward contract provides the lowest .)&(AI+ cost hedging !ethod $or pa#!ent settle!ent2 I$, however, the $ir! believes the ending spot rate will be a w eaker 6on, 6on1,33/ or higher, then the call option would be a lower cost alternative2 (his would re"uire, however, that the $ir! accept $oreign exchange risk and be willing to su$$er the higher cost o$ the call option in the event that the 6on did not $all to the needed level2
Strike
'ut 133
133
13
13333 333 1333
Problem 10. ;attel =o's Hattel is a U2S2*based co!pan# whose sales are roughl# two*thirds in dollars 4Asia and the A!ericas5 and one*third in euros 4)urope52 In Septe!ber Hattel delivers a large ship!ent o$ to#s 4pri!aril# arbies and 0ot 6heels5 to a !aLor distributor in Antwerp2 (he receivable, PD3 !illion, is due in 93 da#s, standard ter!s $or the to# industr# in )urope2 Hattel:s treasur# tea! has collected the $ollowing currenc# and !arket "uotes2 (he co!pan#:s $oreign exchange advisors believe the euro will be at about 12;33/P in 93 da#s2 Hattel:s !anage!ent does not use currenc# options in currenc# risk !anage!ent activities2 Advise Hattel on which hedging alternative is probabl# pre$erable2 .urrent spot rate 4/P5 .redit Suisse 93*da# $orward rate 4/P5 arcla#s 93*da# $orward rate 4/P5 Hattel (o#s 6A.. 45 93*da# eurodollar interest rate 93*da# euro interest rate 93*da# eurodollar borrowing rate 93*da# euro borrowing rate
12;18 12;17 12;198 92E33< ;2333< D28< 82333< 82333<
Assumptions 93*da# A/& 4P5 .urrent spot rate 4/P5 .redit Suisse 93*da# $orward rate 4/P5 arcla#s 93*da# $orward rate 4/P5 )xpected spot rate in 93 da#s 4/P5 93*da# eurodollar interest rate 93*da# euro interest rate I!plied 93*da# $orward rate 4calculated, /P5 93*da# eurodollar borrowing rate 93*da# euro borrowing rate Hattel (o#s weighted average cost o$ capital 45
Values D *0,000,000.00 $1.4158 $1.41+2 $1.41/5 $1.4200 4.000% *.885% $1.412 5.000% 5.000% /.00%
e(!in! Alternati6es
Values
&is Assessment
1. &emain 7nco6ere(, settlin! A3& in /0 (a's at maret rate 43 !illion euros / $uture spot rate5
I$ spot rate in 93 da#s is sa!e as current
$42,4+4,000.00
&isk#
I$ spot rate in 93 da#s is sa!e as .redit Suisse $orward rate
$42,51,000.00
&isk#
I$ spot rate in 93 da#s is sa!e as arcla#s $orward rate
$42,585,000.00
&isk#
I$ spot rate in 93 da#s is expected spot rate
$42,00,000.00
&isk#
Settle!ent a!ount at .redit Suisse $orward rate
$42,51,000.00
.ertain
Settle!ent a!ount at arcla#s $orward rate
$42,585,000.00
.ertain
2. Sell euros for:ar( /0 (a's
*. ;one' ;aret e(!e
'rincipal A/& in euros discount $actor $or euro borrowing rate $or 93 da#s orrow euros against 93*da# A/& .urrent spot rate, /euro US dollar current value Hattel@s 6A.. carr#*$orward $actor $or 93 da#s Future value o$ !one# !arket hedge
D *0,000,000.00 0./8++ D 2/,2/,2/.* $1.4158 $41,/4/,2/.* 1.0240 $42,/5,420.+4
1/41 G 4238 x 93/DE355
1 G 4239E3 x 93/DE35 .ertain
"6aluation of Alternati6es
(he !one# !arket hedge guarantees Hattel the greatest dollar value $or the A/& when using the cost o$ capital as the reinvest!ent rate 4carr#*$orward rate52
'rincipal )uro Spot rate /) $rwd rate /)
D3333333 12;18 12;198
+o hedge 0edge
;;7;333 ;88333
Problem 10./ Compass &ose .o!pass &ose, td2, a .anadian !anu$acturer o$ raincoats, does not selectivel# hedge its transaction exposure2 Instead, i$ the date o$ the transaction is known with certaint#, all $oreign currenc#*deno!inated cash $lows !ust utili=e the $ollowing !andator# $orward contract cover $or!ula% Compass &oseEs ;ana(ator' or:ar( Co6er Paying the points forward Receiving the points forward
0@/0 (a's +5% 100%
/1@180 (a's 0% /0%
F 180 (a's 50% 50%
.o!pass &ose expects to receive !ultiple pa#!ents in anish kroner over the next #ear2 Or D,333,333 is due in 93 da#sR Or ,333,333 is due in 13 da#sR and Or 1,333,333 is due in one #ear2 Using the $ollowing spot and $orward exchange rates, what would be the a!ount o$ $orward cover re"uired b# co!pan# polic# b# period>
Assumptions Spot rate, Or/. D*!onth $orward rate, Or/. E*!onth $orward rate, Or/. 1*!onth $orward rate, Or/. Sout aceEs "#posures A/& due in D !onths, Or A/& due in E !onths, Or A/& due in 1*!onths, Or
or:ar( Giscount
Values 4.+0 4.+1 4.+2 4.+4
@0.85% @0.85% @0.84%
0@/0 (a's *,000,000
/1@180 (a's
F 180 (a's
2,000,000
1,000,000
Anal'sis "#posure ;ana!ement (he anish krone is selling $orward at a discount versus the .anadian dollar% it takes !ore Or/. $orward2 .o!pass &ose is receiving $oreign currenc#, Or, at $uture dates 4long Or52 .o!pass &ose is there$ore expecting to 'AQ (0) 'CI+(S FC&6A&2 &eHuire( or:ar( Co6er for Compass &ose) A/& due in D !onths, Or A/& due in E !onths, Or A/& due in 1*!onths, Or GBr or:ar( Co6er A/& due in D !onths, Or A/& due in E !onths, Or A/& due in 1*!onths, Or )xpected .anadian dollar value o$ Or sold $orward
0@/0 (a's +5%
/1@180 (a's
F 180 (a's
0% 50%
2,250,000
1,200,000
4++,+0+.01
254,2*+.2/
500,000 105,485.2*
Problem 10.8 AHuatec
A"uatech is a U2S2*based co!pan# which !anu$actures, sells, and installs water puri$ication e"uip!ent2 Cn April 11th the co!pan# sold a s#ste! to the .it# o$ +agasaki, Japan, $or installation in +agasaki:s $a!ous Blover Bardens 4where 'uccini:s Hada!e utter$l# waited $or the return o$ t2 'inkerton25 (he sale was priced in #en at ?3,333,333, with pa#!ent due in three !onths2 Spot exchange rate% Cne*!onth $orward rate% (hree*!onth $orward% Cne*#ear $orward% ;one' &ates Cne !onth (hree !onths (welve !onths
?11288/ 4closing !id*rates5 ?11727E3/, a 823;< p2a2 pre!iu! ?11E2D3/, a ;2< p2a2 pre!iu! ?112;83/, a 821E< p2a2 pre!iu! 7nite( States ;2783< ;29D78< 82178<
9apan 3239D78< 3239D78< 32D183<
Gifferential ;2718< ;2;D78< ;27833<
Note: (he interest rate di$$erentials var# slightl# $ro! the $orward discounts on the #en because o$ ti!e di$$erences $or the "uotes2 (he spot ?11288/, $or exa!ple, is a !id*point range2 Cn April 11, the spot #en traded in ondon $ro! ?112D3/ to ?1172883/2
Additional in$or!ation% A"uatech:s Japanese co!petitors are currentl# borrowing #en $ro! Japanese banks at a spread o$ percentage points above the Japanese !one# rate2 A"uatech@s weighted average cost o$ capital is 1E<, and the co!pan# wishes to protect the dollar value o$ this receivable2 Three-month options from Kyushu Bank:
.all option on ?3,333,333 at exercise price o$ ?11233/% a 1< pre!iu!2 'ut option on ?3,333,333, at exercise price o$ ?11233/% a D< pre!iu!2 a5 6hat are the costs and bene$its o$ alternative hedges> 6hich would #ou reco!!end, and wh#> b5 6hat is the break*even reinvest!ent rate when co!paring $orward and !one# !arket alternatives> Assumptions A!ount o$ receivable, Japanese #en 4 ¥5
Spot exchange rate at ti!e o$ sale 4 ¥/5 ooked value o$ sale 4a!ount/spot rate5 a#s receivable due A"uatech@s 6A.. .o!petitor borrowing pre!iu!, #en 4 ¥5 or:ar( rates an( premiums Cne*!onth $orward rate 4 ¥/5 (hree*!onth $orward rate 4 ¥/5 Cne*#ear $orward rate 4 ¥/5
Values 20,000,000 118.255 $1/,12.04 /0 1.0% 2.0% or:ar( &ate 11+.+0 11.8*0 112.450
Premium 5.04% 4.88% 5.1%
n6estment rates, % per annum 1 !onth D !onths 1 !onths
7nite( States 4.8+50% 4./*+5% 5.18+5%
9apan 0.0/*+5% 0.0/*+5% 0.*1250%
Purcase( options D*!onth call option on #en D*!onth put option on #en
Strie -'en3$ 118.000 118.000
Premium 1.0% *.0%
Values
Certaint'
a. Alternati6e e(!es 1. &emain unco6ere(.
Account receivable 4#en5 'ossible spot rate in 93 da#s 4#en/5 .ash settle!ent in 93 da#s 4US5
20,000,000 118.255 $1/,12.04
Uncertain2
2. or:ar( maret e(!e.
Account receivable 4#en5 Forward rate 4won/5 .ash settle!ent in 93 da#s 4US5
20,000,000
11.8*0 $1+1,188./1
.ertain2
*. ;one' maret e(!e.
Account receivable 4#en5 iscount $actor $or 93 da#s Qen proceeds up $ront .urrent spot rate 4won/5 US dollars received now .arr# $orward at A"uatech@s 6A.. 'roceeds in 93 da#s 4. Put option e(!e. ->ee( to sell 'en put on 'en Cption principal .urrent spot rate 4won/5 're!iu! cost o$ option 4<5 Cption p! 4principal/spot rate x < p!5
I$ option exercised, dollar proceeds ess '! carried $orward 93 da#s +et proceeds in 93 da#s
20,000,000 1.0052* 1/,8/5,858 118.255 $18,245.*8
1.0400 $1+4,/+5.20
1 G 4423339D78 G 235 x 93/DE35
1 G 421E x 93/DE35 .ertain2
20,000,000 118.255 *.000% $5,0+*.+8 $1/,4/1.5*
-5,2+.+*2 $14,214.+/
123; carr#*$orward rate Hini!u!2
(he put option does n ot BUA&A+()) the co!pan# o$ settling $or the booked a!ount2 (he !one# !arket and $orward hedges doR the !one# !arket #ielding the higher proceeds2 b reae6en rate bet:een te mone' maret an( t e for:ar( e(!e is (etermine( b' te rein6estment rate) $18,245.*8 Hone# !arket, US up*$ront $1+1,188./1 Forward contract, US, end o$ 93 da#s 101.+50% 41 G x5 1E,;82D 41Gx5 M 171,1291 1.+4/54% x For 93 da#s reakeven rate, < per annu! $0.0//8
Problem 10.12 uc' 1* uck# 1D Jeans o$ San Antonio, (exas, is co!pleting a n ew asse!bl# plant near Buate!ala .it#2 A $inal construction pa#!ent o$ T,;33,333 is due in six !onths2 4TV is the s#!bol $or Buate!alan "uet=als25 uck# 1D uses 3< per annu! as its weighted average cost o$ capital2 (oda#:s $oreign exchange and interest rate "uotations are as $ollows%
.onstruction pa#!ent due in six*!onths 4A/', "uet=als5 'resent spot rate 4"uet=als/5 Six*!onth $orward rate 4"uet=als/5 Buate!alan six*!onth interest rate 4per annu!5 U2S2 dollar six*!onth interest rate 4per annu!5 uck# 1D@s weighted average cost o$ capital 46A..5
8,400,000 +.0000 +.1000 14.000% .000% 20.000%
uck# 1D@s treasur# !anager, concerned about the Buate!alan econo!#, wonders i$ uck# 1D should be hedging its $oreign exchange risk2 (he !anager:s own $orecast is a s $ollows% )xpected spot rate in six*!onths 4"uet=als/5% 0ighest expected rate 4re$lecting a signi$icant devaluation5 )xpected rate owest expected rate 4re$lecting a strengthening o$ the "uet=al5
8.0000 +.*000 .4000
6hat realistic alternatives are available to uck# 1D $or !aking pa#!ents> 6hich !ethod would #ou select and wh#> Iat realistic alternati6es are a6ailable to uc' 1*J
Cost
Certaint'
1. Iait si# monts an( mae pa'ment at spot rate
0ighest expected rate
$
1,050,000.00
&is'
)xpected rate
$
1,150,84./*
&is'
owest expected rate
$
1,*12,500.00
&is'
$
1,18*,0/8.5/
Certain
$ $
+,850,4+.2/ 1,121,4/5.** 1.10 1,2**,44.8
Certain
2. Purcase Huet?als for:ar( si#@monts 4A/' divided b# the $orward rate5 *. =ransfer (ollars to Huet?als to(a', in6est for si#@monts "uet=als needed toda# 4A/' discounted 13 da#s5 .ost in dollars toda# 4"uet=als to at spot rate5 $actor to carr# dolla rs $orward 13 d a#s 41 G 46A../55 .ost in dollars in six*!onths 4 carried $orward 13 da#s 5
(he second choice, the $orward contract, results in the lowest cost alternative a!ong certain alternatives2
Problem 10.10 Pupule =ra6el 'upule (ravel, a 0onolulu, 0awaii N based 133< privatel# owned travel co!pan# has signed an agree!ent to ac"uire a 83< ownership share o$ (aichung (ravel, a (aiwan N based privatel# owned travel agenc# speciali=ing in servicing inbound custo!ers $ro! the United States and .anada2 (he ac"uisition price is 7 !illion (aiwan dollars 4( 7,333,3335 pa#able in cash in D !onths2 (ho!as .arson, 'upule (ravel:s owner, believes the (aiwan dollar will either re!ain stable or decline a little over the next D !onths2 At the present spot rate o$ (D8/, the a!ount o$ cash re"uired is onl# 33,333 but even this relativel# !odest a!ount will need to be borrowed personall# b# (ho!as .arson2 (aiwanese interest*bearing deposits b# non*residents are regulated b# the govern!ent, and are currentl# set at 128< per #ear2 0e has a credit line with ank o$ 0awaii $or 33,333 with a current borrowing interest rate o$ < per #ear2 0e does not believe that he can calculate a credible weighted average cost o$ capital since he has n o stock outstanding and his co!petitors are all also privatel#*owned without disclosure o$ their $inancial results2 Since the ac"uisition would use up all his available credit, he wonders i$ he should hedge this transaction exposure2 0e has "uotes $ro! ank o$ 0awaii shown in the table below2
Spot rate 4(/5 D*!onth $orward rate 4(/5 D*!onth (aiwan dollar deposit rate D*!onth dollar borrowing rate D*!onth call option on (
DD2;3 D2;3 12833< E2833< not available
Anal#=e the costs and risks o$ each alternative, and then !ake a reco!!endation as to which alternative (ho!as .arson should choose2 Assumptions Ac"uisition price D*!onth A/', +ew(aiwan dollars 4(5 Spot rate 4(/5 D*!onth $orward rate 4(/5 D*!onth (aiwan dollar deposit rate D*!onth dollar borrowing rate D*!onth call option on ( (ho!as .arson@s credit line with ank o$ 0awaii
$
"6aluation of Alternati6es
Values +,000,000 **.40 *2.40 1.500% .500% not a6ailable 200,000 Cost
Certaint'
1. Go >otin! @@ Iait * monts an( bu' =$ spot
I$ spot rate is the sa!e as current spot rate
$
20/,580.84
&is'
I$ spot rate is the sa!e as D*!onth $orward rate
$
21,04/.*8
&is'
$
21,04/.*8
Certain
Although this would do nothing to cover the currenc# risk, there would be no re"uired pa#!ent or borrowing $or D *!onths2 2. u' =$ for:ar( *@monts
Assured cost o$ ( at D*!onth $orward rate (he purchase o$ a $orward contract would not re"uire an# cash up*$ront, but the ank o$ 0awaii would reduce his available credit line b# the a!ount o$ the $orward2 (his is a non*cash expense2
*. ;one' ;aret e(!e) "#can!in! 7S$ for =$ no:, (epositin! for *@monts until pa'ment
Ac"uisition price in ( needed in D*!onths iscounted back D*!onths at ( deposit rate A!ount o$ +( needed now $or deposit Spot rate, (/ US needed now $or exchange US carr#*$orward rate 4D*!onth dollar borrowing rate5 .arr#*$orward $actor o$ US $or D*!onth period (otal cost in US o$ settling A/' in D*!onths with Hone# Harket 0edge
$
+,000,000 0.//* ,/+*,848 **.40 208,+/+.85
$
.500% 1.01* 212,1/0.81
Certain
(he currenc# risk is eli!inated, but since (ho!as .arson would have to exchange the !one# up $ront, it w ould re"uire hi! to borrow the !one#, increasing his debt outstanding $or the entire D !onths2 Giscussion.
(his is a di$$icult decision2 (he $orward contract appears to be the pre$erable choice, protecting hi! against an appreciating (, and creating a certain cash purchase pa#!ent2 (he proble!, however, will be whether the ank o$ 0awaii will allow hi! to purchase a $orward $or the $ull 1E,3;92D, which is slightl# above his credit line currentl# in place2 I$ his relationship is good with the bank, the# !ost likel# would increase his line su$$icientl# to allow the $orward contract2
Problem 10.11 Cronos =ime Pieces
.hronos (i!e 'ieces o$ oston exports wrist watches to !an# countries, selling in local currencies to watch stores and distributors2 .hronos prides itsel$ on being $inanciall# conservative2 At least 73< o$ each individual transaction exposure is hedged, !ostl# in the $orward !arket, but occasionall# with options2 .hronos@s $oreign exchange polic# is s uch that the 73< hedge !a# be increased up to a 13< hedge i$ devaluation or depreciation appears i!!inent2 .hronos has Lust shipped to its !aLor +orth A!erican distributor2 It has issued a 93*da# invoice to its bu#er $or P1,8E3,3332 (he current spot rate is 12;/P, the 93*da# $orward rate is 1273/P2 .hronos:s treasurer, Hann# 0ernande=, has a ver# good track record in predicting exchange rate !ove!ents2 0e currentl# believes the euro will weaken against the dollar in the co!ing 93 to 13 da#s, possibl# to around 121E/P2
Assumptions Account recievable in 93 da#s 4P5 Initial spot exchange rate 4/P5 Forward rate, 93 da#s 4/P5 )xpected spot rate in 93 to 13 da#s 4/P5% .ase W1 )xpected spot rate in 93 to 13 da#s 4/P5% .ase W
Values D 1,50,000 $1.2224 $1.22+0 $1.100 $1.200 e(!e( te ;inimum
e(!e( te ;a#imum
Proportion of e#posure to be e(!e( (otal exposure 4P5 hedged proportion Hini!u! hedge in euros 4exposure x !in prop5 at the $orward rate 4/P5 locking in 45
+0% D 1,50,000 +0% D 1,0/2,000 $1.22+0 $1,**/,884
120% D 1,50,000 120% D 1,8+2,000 $1.22+0 $2,2/,/44
Case L1) "n(in! spot rate 'roportion uncovered 4short5 I$ ending spot rate is 4/P5 Kalue o$ uncovered proportion 45
D 48,000 $1.100 $542,880
-D *12,000 $1.100 -$*1,/20
Kalue o$ covered proportion 4$ro! above5
$1,**/,884
$2,2/,/44
(otal net proceeds, covered G uncovered
$1,882,+4
$1,/*5,024
Case L2) "n(in! spot rate 'roportion uncovered 4short5 I$ ending spot rate is 4/P5 value o$ uncovered proportion 45
D 48,000 $1.200 $58/,80
-D *12,000 $1.200 -$*/*,120
f Cronos =ime Pieces KK
Kalue o$ covered position 4$ro! above5 (otal net proceeds, covered G uncovered encmar) ull -100% for:ar( co6er
$
1,**/,884
$
2,2/,/44
$1,/2/,54
$1,/0*,824
$1,/14,120
$1,/14,120
(his is not a conservative hedging polic#2 An# ti!e a $ir! !a# choose to leave an# proportion uncovered, or purchase cover $or !ore than the exposure 4there$ore creating a net short position5 the $ir! could experience nearl# unli!ited losses or gains2
Problem 10.14 ;icca ;etals, nc. Hicca Hetals, Inc2 is a specialt# !aterials and !etals co!pan# located in etroit, Hichigan2 (he co!pan# speciali=es in speci$ic precious !etals and !aterials which are used in a variet# o$ pig!ent applications in !an# other industries including cos!etics, appliances, and a variet# o$ high tinsel !etal $abricating e"uip!ent2 Hicca Lust purchased a ship!ent o$ phosphates $ro! Horocco $or E,333,333, dirha!s, pa#able in six !onths2 Hicca:s cost o$ capital is 2E33<2
Six*!onth call options on E,333,333 dirha!s at an exercise price o$ 13233 d irha!s per dollar are available $ro! ank Al* Haghrub at a pre!iu! o$ <2 Six*!onth put options on E,333,333 dirha!s at an exercise price o$ 13233 dirha!s per dollar are available at a pre!iu! o$ D<2 .o!pare and contrast alternative wa#s that Hicca !ight hedge its $oreign exchange transaction exposure2 6hat is #our reco!!endation> Assumptions Ship!ent o$ phosphates $ro! Horocco, Horoccan dirha!s Hicca@s cost o$ capital 46A..5 Spot exchange rate, d irha!s/ Six*!onth $orward rate, dirha!s/
Values ,000,000 14.000% 10.00 10.40
Cptions on Horoccan dirha!s% Strike price, dirha!s/ Cption pre!iu! 4percent5
Six*!onth interest rate $or borrowing 4per annu!5 Six*!onth interest rate $or investing 4per annu!5 &is ;ana!ement Alternati6es 1. &emain unco6ere(, main! te (iram pa'ment in si# monts at te spot rate in effect at tat (ate Account pa#able 4dirha!s5 'ossible spot rate in six !onths ** the current spot rate 4dirha!s/5 .ost o$ settle!ent in six !onths 4US5
Put ption 10.00 *.000%
7nite( States .000% 5.000%
;orocco 8.000% +.000%
Values
Certaint'
$
,000,000 10.00 00,000.00
Uncertain2
$
,000,000 10.40 5+,/2*.08
Uncertain2
$
,000,000 10.40 5+,/2*.08
.ertain2
*. ;one' maret e(!e. "#can!e (ollars for (irams no:, in6est for si# monts. Account pa#able 4dirha!s5 ,000,000.00 1.0*5 iscount $actor at the dirha! investing rate $or E !onths 5,+/+,101.45 irha!s needed now $or investing 4pa#able/discount $actor5 10.00 .urrent spot rate 4dirha!s/5 US dollars needed now $ 5+/,+10.14 1.0+0 .arr# $orward rate $or six !onths 46A..5 $ 20,28/.8 US dollar cost, in six !onths, o$ settle!ent
.ertain2
Account pa#able 4dirha!s5 'ossible spot rate in six !onths ** $orward rate 4dirha!s/5 .ost o$ settle!ent in six !onths 4US5
Call ption 10.00 2.000%
2. or:ar( maret e(!e. u' (irams for:ar( si# monts.
Account pa#able 4dirha!s5 Six !onth $orward rate, dirha!s/ .ost o$ settle!ent in six !onths 4US5
4. Call option e(!e. ->ee( to bu' (irams call on (irams Cption principal .urrent spot rate, dirha!s/ 're!iu! cost o$ option Cption pre!iu! 4principal/spot rate x < p!5
I$ option exercised, dollar cost at strike price o$ 13233 dirha!s/ 'lus pre!iu! carried $orward six !onths 4p! x 1237, 6A..5 (otal net cost o$ call option hedge i$ exercised
$ $ $
,000,000.00 10.00 2.000% 12,000.00 00,000.00 12,840.000 12,840.00
Haxi!u!2
(he lowest cost certain alternative is the $orward2 I$ Hicca were to expect the dirha! to depreciate signi$icantl# over the next six !onths, it !a# choose the call option2
A' iscount principal needed )uivalent .C. (otal Ap
E,333,333 329EE1D87;9 8,797,1312;8 ir 87971321;;9D 1237 E3928837
123D8
Problem 10.1* urton ;anufacturin! Jason Sted!an is the director o$ $inance $or urton Hanu$acturing, a U2S2*based !anu$acturer o$ hand*held co!puter s#ste!s $or inventor# !anage!ent2 urton:s s#ste! co!bines a low*cost active bar*code used on inventor# 4the bar*code tags e!it an extre!el# low*grade radio $re"uenc#5 with custo!*designed hardware and so$tware which tracks the low*grade e!issions $or inventor# control2 urton has co!pleted the sale o$ a bar*code s#ste! to a ritish $ir!, 'egg Hetropolitan 4UO5, $or a total pa#!ent o$ X1,333,3332 (he $ollowing exchange rates were available to urton on the $ollowing dates corresponding to the events o$ this speci$ic export sale2 Assu!e each !onth is D3 da#s2
Gate
"6ent
Februar# 1 Harch 1
'rice "uotation $or 'egg .ontract signed $or sale .ontract a!ount, pounds 'roduct shipped to 'egg 'roduct received b# 'egg Brand Het !akes pa#!ent
June 1 August 1 Septe!ber 1
Spot &ate -$3< 1.+850 1.+45 <1,000,000 1.+8/ 1.+840 1.+2/0
or:ar( &ate -$3< 1.+++1 1.+*81
Ga's or:ar( of or:ar( &ate 210 180
1.+02 1.+811 @@@@@@@@@
/0 *0 @@@@@@@@@
Anal'sis
a2 (he sale is booked at the exchange rate existing on June 1, when the product is shipped to 'egg Hetropolitan, and the ship!ent is categori=ed as an account receivable2 (his sale is then co!pared to that value in e$$ect on the date o$ cash settle!ent, the di$$erence being the $oreign exchange gain 4loss52 Kalue as settled Kalue as booked F- gain 4loss5
1 !illion pounds 12793/pound 1 !illion pounds 127E9/pound
$1,+2/,000 $1,+8,/00 -$*/,/00
b2 (he value o$ the $oreign exchange gain 4loss5 will depend upon when Jason actuall# purchases the $orward contract2 ecause !an# $ir!s do not de$ine an exposure as arising until the date that the product is shipped 4loss o$ ph#sical control over the goods5 and the sale is booked on the inco!e state!ent, that is a co!!on date $or the purchase o$ the $orward contract2 or:ar( contract purcase( on 9une 1
Kalue o$ $orward settle!ent Kalue as booked F- gain 4loss5
1 !illion pounds 127E3/pound 1 !illion pounds 127E9/pound
$1,+0,200 $1,+8,/00 -$8,+00
A !ore aggressive alternative is $or Jason to purchase the $orward contract on the date that the contract was signed, Harch 1, locking* in urton@s U2S2 dollar settle!ent a!ount a $ull 93 da#s earlier in the transaction exposure@s li$e span2 or:ar( contract purcase( on ;arc 1
Kalue o$ $orward settle!ent Kalue as booked F- gain 4loss5
1 !illion pounds 127D1/pound 1 !illion pounds 127E9/pound
$1,+*8,100 $1,+8,/00 -$*0,800
+ote that in this case i$ Jason had covered $orward on Harch 1st rather than June 1st, the a!ount o$ the $oreign exchange loss would have been even greater, although $ull# hedged2 (he di$$erence is o$ course the result o$ the $orward rate changing with spot rates and interest di$$erentials2
Problem 10.15 ;aria on?ale? an( =ri(ent (rident Y the sa!e U2S2*based co!pan# discussed in this chapter, has concluded a second larger sale o$ teleco!!unications e"uip!ent to &egenc# 4U2O252 (otal pa#!ent o$ XD,333,333 is due in 93 da#s2 Haria Bon=ale= has also learned that (rident will onl# be able to borrow in the United Oingdo! at 1;< per annu! 4due to credit concerns o$ the ritish banks52 Biven the $ollowing exchange rates and interest rates, w hat transaction exposure hedge is now in (rident:s best interest>
Assumptions 93*da# A/& in pounds Spot rate, US per pound 4/ £5 93*da# $orward rate, US per pound 4/ £5 D*!onth U2S2 dollar invest!ent rate D*!onth U2S2 dollar borrowing rate D*!onth UO invest!ent interest rate D*!onth UO borrowing interest rate 'ut options on the ritish pound% Strike rates, US/pound 4/ £5 Strike rate 4/X5 'ut option pre!iu! Strike rate 4/X5 'ut option pre!iu! (rident@s 6A.. Haria Bon=ale=@s expected spot rate in 93 da#s, US per pound 4/ £5
Value <*,000,000.00 $1.+20 $1.+550 .000% 8.000% 8.000% 14.000% $1.+5 1.500% $1.+1 1.000% 12.000% $1.+850
Alternati6e L1) &emain 7nco6ere( Kalue o$ A/& will be 4D !illion pounds x ending spot rate 4/pound55 I$ spot rate is the sa!e as current spot rate I$ ending spot rate is the sa!e as current $orward rate I$ ending spot rate is the expected spot rate
&ate -$3poun(
Procee(s
$1.+20 $1.+550 $1.+850
$5,28,000.00 $5,25,000.00 $5,*55,000.00
Alternati6e L2) or:ar( Contract e(!e Sell the pounds $orward D !onths, locking in the $orward rate 'ound A/& at the $orward rate 4pounds x $orward5
&ate -$3poun(
Procee(s
$1.+550
$5,25,000.00
Alternati6e L*) ;one' ;aret e(!e orrows against the A/&, receiving X up*$ront, exchanging into US2 A!ount o$ A/& in 93*da#s, in pounds iscount $actor, pound borrowing rate, $or D*!onths 'roceeds o$ borrowing, up*$ront, in pounds )xchanged to US at current spot rate o$ US received against A/&, up*$ront US need to be carried $orward $or co!parison% .arr#*$orward rate, 6A.. $or 93 da#s Hone# Harket 0edge, US, at end o$ 93 da#s
&ate -$3poun(
Procee(s
$1.+20
$5,10+,24.*8
Alternati6e L4) Put ption e(!es
Cption pre!iu! +otional principal o$ option 4pounds5 Spot rate 4/pound5 Cption pre!iu!, US .arr#*$orward $actor, 6A.., $or 93 da#s (otal pre!iu! cost, in 93 da#s 'roceeds $ro! put option i$ exercised ess cost o$ pre!iu!, including ti!e*value +et proceeds $ro! put options, in 93 da#s% Hini!u! )nding spot rate needed to be s uperior to $orward% 'roceeds $ro! exchanging pounds $or US spot ess cost o$ option 4allowed to expire C(H5 +et proceeds $ro! put option, unexercised
<*,000,000.00 0./2 <2,8/8,550.+2
1.0*00 $5,20,4*.++
Strie &ate -$3pn( 1.+5 1.500% <*,000,000.00 $1.+20 $+/,2/0.00 1.0*00 $81,8.+0
Strie &ate -$3pn( 1.+1 1.000% <*,000,000.00 $1.+20 $52,80.00 1.0*00 $54,445.80
$5,250,000.00 -81,8.+0 $5,18,**1.*0
$5,1*0,000.00 -54,445.80 $5,0+5,554.20
$1.+825 $5,*4+,500.00 -81,8.+0 $5,25,8*1.*0
$1.++*2 $5,*1/,00.00 -54,445.80 $5,25,154.20
Anal#sis% Haria Bon=ale= would receive the !ost certain US $ro! the $orward contract, 8,E8,333R the !one# !arket hedge is less attractive as a result o$ the higher borrowing costs in the U2O2 now2 (he two put options would #ield unattractive a!ounts i$ the# had to be exercised2 As shown, the 1278 strike price put option would be superior to the $orward i$ the ending spot rate were 1278 or higherR the 1271 strike price would be superior to the $orward i$ the ending spot rate were 1277D or higher2
Problem 10.1 arin '(raulics Cn Ha# 1st, arkin 0#draulics, a wholl# owned subsidiar# o$ .aterpillar 4U2S25, sold a 1 !egawatt co!pression turbine to &ebecke* (erwilleger .o!pan# o$ the +etherlands $or P;,333,333, pa#able P,333,333 on August 1st and P,333,333 on +ove!ber 1st2 arkin derived its price "uote o$ P;,333,333 on April 1st b# dividing its nor!al U2S2 dollar sales price o$ ;2D3,333 b# the then current spot rate o$ 12333/P2
# the ti!e the order was received and booked on Ha# 1st, the euro had strengthened to 121333/P, so the sale was in $act worth P;,333,333 x 121333/P M ;,;33,3332 arkin had alread# gained an extra 3,333 $ro! $avorable exchange rate !ove!ents2 +evertheless arkin@s director o$ $inance now wondered i$ the $ir! should hedge against a reversal o$ the recent trend o$ the euro2 Four approaches were possible%
12 0edge in the $orward !arket2 (he D*!onth $orward exchange "uote was 1213E3/P and the E*!onth $orward "uote was 1211D3/P2 2 0edge in the !one# !arket2 arkin could borrow euros $ro! the Frank$urt branch o$ its U2S2 bank at 233< per annu!2 D2 0edge with $oreign currenc# options2 August put options were available at a strike price o$ 121333/P $or a pre!iu! o$ 23< per contract, and +ove!ber put options were available at 121333/P $or a pre!iu! o$ 12<2 August call options at 121333/P could be purchased $or a pre!iu! o$ D23<, and +ove!ber call options at 121333/P were available at a 2E< pre!iu!2 ;2 o nothing2 arkin could wait until the sales proceeds were received in August and +ove!ber, hope the recent strengthening o$ the euro would continue, and sell the euros received $or dollars in the spot !arket2 arkin esti!ates the cost o$ e"uit# capital to be 1< per annu!2 As a s!all $ir!, arkin 0#draulics is unable to raise $unds with long*ter! debt2 U2S2 (*bills #ield D2E< per annu!2 6hat should arkin do> Assumptions 93*da# Forward rate, / € 13*da# Forward rate, / € US (reasur# bill rate arkin@s borrowing rate, euros, per annu! arkin@s cost o$ e"uit# ptions on euros August !aturit# options +ove!ber !aturit# options
Values $1.100 $1.11*0 *.00% 8.000% 12.000% Strie -$3euro $1.1000 $1.1000
=o(a' is ;a' 1 "#can!e &ate -$3 € $1.0800 $1.1000
Gate April 1 ;a' 1
Call ption *.0% 2.%
Put ption 2.0% 1.2%
Au!ust &ecei6able D 2,000,000
>o6ember &ecei6able D 2,000,000
A!ount o$ receivable, in euros &espective $orward rates 4/ €5 US dollar proceeds as hedged 45 .arr# $orward to +ov 1st at 6A.. (otal US proceeds on +ov 1st (otal o$ both pa#!ents
D 2,000,000 $1.100 $2,212,000 1.0* $2,2+8,*0
D 2,000,000 $1.11*0 $2,22,000 @@@@@ $2,22,000
A!ount o$ receivable, in euros iscount $actor $or euro $unds, period .urrent proceeds $ro! discounting, euros .urrent spot rate 4/ €5 .urrent US dollar proceeds .arr# $orward rate $or the period US dollar proceeds on $uture date (otal o$ both pa#!ents
D 2,000,000 1.02 D 1,/0,+84 $1.1000 $2,15,8* 1.0
D 2,000,000 1.04 D 1,/2*,0++ $1.1000 $2,115,*85 1.0
$2,28,2+5
$2,242,*08
A!ount o$ receivable, in euros u# put options $or !aturities 4< x spot value5 .arr# $orward $or the period 're!iu! cost carried $orward to +ov 1
D 2,000,000 -$44,000 1.0 -$4,40
D 2,000,000 -$2,400 1.0 -$2+,/84
$2,200,000 1.0*
$2,200,000 @@@@
$2,2,000
$2,200,000
Valuation of Alternati6e e(!es A!ount o$ receivable, in euros a. e(!e in te for:ar( maret
$4,504,*0
b. e(!e in te mone' maret
$4,528,582
c. e(!e :it options
Bross put option value i$ exercised .arried $orward D !onths to +ov 1 Bross proceeds, +ov 1 (otal net proceeds, a$ter pre!iu! deduction, +ov 1
$4,*/1,*+
(. Go notin! -remain unco6ere(
A!ount o$ receivable, in euros )nding spot exchange rate 4/ €5
D 2,000,000 JJJ
D 2,000,000 JJJ
(he !one# !arket hedge provides the highest certain outco!e2 I$ arkin 0#draulics believes the euro will strengthen versus the dollar over the co!ing !onths, and it is willing to take the currenc# risk, the put option hedges could be considered2
;ini@Case) anbur' mpe# -n(ia apura@s (urkish sale is $or ( DE9,8 483,333 at the current spot rate o$ (12;79D/52 (he receivable is $or settle!ent E3 da#s $ro! now 4end o$ Januar#, it is currentl# the end o$ +ove!ber52 Since apura has no real insight ** or view ** on the direction o$ exchange rate !ove!ents, there is no !otivation to use currenc# options2 Cptions re"uire a directional view b# the user i$ the# are to be considered pre$erable to $orward contracts2 Assumptions Indian rupees per US dollar Indian rupees per euro Japanese #en per rupee Indian rupees per (urkish lira (urkish lira per US dollar US dollars per euro 4calculated5 (urkish lira per euro 4calculated5 Currenc' of n6oice "6aluation of Alternati6es ri!inal recei6able Spot rate -=uris lira per currenc' &e(enominate( recei6able -0 (a's or:ar( rate ->&3currenc' n(ian rupee procee(s in 0 (a's
Spot 45.8*00 0./11 1.8250 *0.+1/2 1.4+/* 1.**02 1./++
0@Ga' or:ar( 4.+000 1./000 1.8100 *0./500 1.4800 1.*255 1./1+
=uris lira "#posure */,825 = @@@@@ */,825 = *0./500 >& 11,44,084
7S (ollar "#posure */,825 = 1.4+/* $250,000 4.+000 >& 11,+5,000
"uro "#posure */,825 = 1./++ D 18+,/48 1./000 >& 11,**,/4
.hoosing the currenc# o$ invoice is a "uestion o$ which hedge, i$ an#, apura uses2 I$ the E3*da# $orward rates are applied to the three di$$erent currenc# o$ invoice choices, the greatest I+& proceeds result $ro! using a dollar currenc# o$ invoice and covering the exposure with a E3*da# $orward rate to sell dollars $or rupees2 Although apura could leave the receivable uncovered, given the volatilit# o$ exchange rate !arkets, and how cheap $orwards are at this ti!e 4!eaning the# di$$er little $ro! the current spot rate as a result o$ such low interest rates in the dollar, euro, and #en !arkets5, it would !ean taking on unneeded risk2 A !one# !arket hedge would be extre!el# di$$icult to acco!plish in the i!!ediate ti!e $ra!e2 (he need $or a bank relationship, the establish!ent o$ a line o$ credit in order to secure a loan, and the unattractive interest rates 4the (urkish lira borrowing rate would cut severel# into the value o$ the receivable5, all !ake the !one# !arket hedge i!practical $or this sale2
