Spot rate, ¥/$ ¥111.40/$
30-day forward rate, ¥/$ ¥111.00/$
Assumptions Values
BioTron’s 30-day account receivable, Japanese yen 12,500,000
Spot rate, ¥/$ 111.40
30-day forward rate, ¥/$ 111.00
90-day forward rate, ¥/$ 110.40
180-day forward rate, ¥/$ 109.20
Brent Bush should compare two basic alternatives, both of which eliminate the currency risk.
1. Allow the discount and receive payment in Japanese yen in cash
Account recievable (yen) 12,500,000
2. Not offer any discounts for early payment and cover exposure with forwards
Account receivable (yen) 12,500,000
Problem 10.1 BioTron Medical, Inc.
How much in U.S. dollars will BioTron Medical receive 1) with the discount and 2) with no discount but fully
covered with a forward contract?
Brent Bush, CFO of a medical device manufacturer, BioTron Medical, Inc., was approached by a Japanese
customer, Numata, with a proposal to pay cash (in yen) for its typical orders of ¥12,500,000 every other month
if it were given a 4.5% discount. Numata’s current terms are 30 days with no discounts. Using the following
quotes and estimated cost of capital for Numata, Bush will compare the proposal with covering yen payments
with forward contracts.
90-day forward rate, ¥/$ ¥110.40/$
180-day forward rate, ¥/$ ¥109.20/$
Assumptions Values
Purchase price of Korean manufacturer, in Korean won 7,500,000,000
Less initial payment, in Korean won (1,000,000,000)
United States Korea
Six-month investment (not borrowing) interest rate (per annum) 4.000% 16.000%
Borrowing premium of 2.000% 2.000% 2.000%
Six-month borrowing rate (per annum) 6.000% 18.000%
Risk Management Alternatives Values Certainty
1. Remain uncovered, making the won payment in 6 months
at the spot rate in effect at that date
Account payable (won) 6,500,000,000
2. Forward market hedge. Buy won forward six months
Account payable (won) 6,500,000,000
3. Money market hedge. Exchange dollars for won now, invest for six months.
Account payable (won) 6,500,000,000
Problem 10.2 Bobcat Company
Bobcat can invest at the rates given above, or borrow at 2% per annum above those rates. Bobcat’s weighted average cost of capital is
10%. Compare alternate ways that Bobcat might deal with its foreign exchange exposure. What do you recommend and why?
Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and
bolts for heavy equipment. The purchase price was Won7,500 million. Won1,000 million has already been paid, and the remaining
Won6,500 million is due in six months. The current spot rate is Won1,110/$, and the 6-month forward rate is Won1,175/$. The six-
month Korean won interest rate is 16% pe annum, the six-month US dollar rate is 4% per annum. Bobcat can invest at these interest
rates, or borrow at 2% per annum above those rates. A six-month call option on won with a 1200/$ strike rate has a 3.0% premium,
while the six-month put option at the same strike rate has a 2.4% premium.
111
4. Call option hedge. (Need to buy won = call on won)
If exercised If not exercised
Option principal 6,500,000,000
Current spot rate (won/$) 1,110.00 1,300.00
Assumptions Value
US dollar debt taken out in June 1997 50,000,000$
Calculation of Foreign Exhange Loss on Repayment of Loan
At the time the loan was acquired, the scheduled repayment of dollar
and baht amounts would have been as follows:
Scheduled Repayment:
Repayment of US dollar debt: Principal 50,000,000$
Repayment of US dollar debt: Interest 4,200,000
Total repayment 54,200,000$
Actual Repayment:
Repayment of US dollar debt: Principal 50,000,000$
Repayment of US dollar debt: Interest 4,200,000
Siam Cement, the Bangkok-based cement manufacturer, suffered enormous losses with the coming of the
Asian crisis in 1997. The company had been pursuing a very aggressive growth strategy in the mid-1990s,
taking on massive quantities of foreign currency denominated debt (primarily U.S. dollars). When the Thai
baht (B)was devalued from its pegged rate of B25.0/$ in July 1997, Siam’s interest payments alone were
over $900 million on its outstanding dollar debt (with an average interest rate of 8.40% on its U.S. dollar
debt at that time). Assuming Siam Cement took out $50 million in debt in June 1997 at 8.40% interest, and
had to repay it in one year when the spot exchange rate had stabilized at B42.0/$, what was the foreign
exchange loss incurred on the transaction?
Problem 10.3 Siam Cement
Assumptions Values
180-day account payable, Japanese yen (¥)
8,500,000
Spot rate (¥/$)
120.60
Spot Risk
Hedging Alternatives Values Rate (Rp/$) Assessment
1. Remain Uncovered, settling A/P in 180 days at spot rate
3,365,464.34 2.5257 Risky
3,541,666.67 2.4000 Risky
3,269,230.77 2.6000 Risky
2. Buy Japanese yen forward 180 days
Settlement amount at forward rate (Rs)
3,541,666.67 2.4000 Certain
3. Money Market Hedge
Principal A/P (¥) 8,500,000.00
Current spot rate (¥/Rs) 2.5257
3,340,411.26
3,540,835.94 Certain
4. Indian Currency Agent Hedge
Principal A/P (¥) 8,500,000.00
Current spot rate (¥/Rs) 2.5257
Current A/P (Rs)
3,365,464.34
3,538,482.87 Certain
Problem 10.4 P & G India
Proctor and Gamble’s affiliate in India, P & G India, procures much of its toiletries product line from a Japanese company. Because of the
shortage of working capital in India, payment terms by Indian importers are typically 180 days or longer. P & G India wishes to hedge a 8.5
million Japanese yen payable. Although options are not available on the Indian rupee (Rs), forward rates are available against the yen.
Additionally, a common practice in India is for companies like P & G India to work with a currency agent who will, in this case, lock in the
current spot exchange rate in exchange for a 4.85% fee. Using the following exchange rate and interest rate data, recommend a hedging
strategy.
Risk
Alternatives Values Assessment
1. Remain Uncovered.
Settle A/R in 90 days at current spot rate.
If spot rate in 90 days is same as current
$174,603.17 Risky
$175,531.91 Risky
$165,829.15 Risky
(Rp 1,650,000,000 / Rp 9,450/$)
2. Sell Indonesian rupiah forward.
A/R sold forward 90 days
$165,829.15 Certain
Analysis
The Indonesian rupiah has been highly volatile in recent years. This means that during the 90-day period,
any variety of economic or political or social events could lead to an upward bounce in the exchange rate,
reducing the dollar proceeds at settlement to an unacceptable level.
Problem 10.5 Elan Pharmaceuticals
Elan Pharmaceuticals, a U.S.-based multinational pharmaceutical company, is evaluating an export sale of its
cholesterol-reduction drug with a prospective Indonesian distributor. The purchase would be for 1,650 million
Indonesian rupiah (Rp), which at the current spot exchange rate of Rp9,450/$, translates into nearly $175,000.
Although not a big sale by company standards, company policy dictates that sales must be settled for at least a
Assumptions Values At Spot
Assumptions Values
Receivable due in one year, US dollars $80,000,000
Risk
Analysis Values Assessment
Net exposure at time of cash settlements:
One year A/R due $80,000,000
Cash settlement of the net position:
Brazilian reais in one year at current spot rate R$ 109,440,000.00 Risky
Problem 10.6 Embraer of Brazil
Embraer of Brazil is one of the two leading global manufacturers of regional jets (Bombardier of Canada is the other).
Regional jets are smaller than the traditional civilian airliners produced by Airbus and Boeing, seating between 50 and 100
people on average. Embraer has concluded an agreement with a regional U.S. airline to produce and deliver four aircraft one
year from now for $80 million. Although Embraer will be paid in U.S. dollars, it also possesses a currency exposure of inputs
– it must pay foreign suppliers $20 million for inputs one year from now (but they will be delivering the sub-components
throughout the year). The current spot rate on the Brazilian real (R$) is R$1.8240/$, but it has been steadily appreciating
against the U.S. dollar over the past three years. Forward contracts are difficult to acquire and considered expensive. Citibank
Brasil has not explicitly provided Embraer a forward rate quote, but has stated that it will probably be pricing a forward off the
current 4.00% U.S. dollar eurocurrency rate and the 10.50% Brazilian government deposit note.
Spot exchange rate: ¥118.255 ¥118.255/$ (closing mid-rates)
One-month forward rate: ¥117.760 5.04%
a) What are the costs and benefits of alternative hedges? Which would you recommend, and why?
b) What is the breakeven reinvestment rate when comparing forward and money market alternatives?
Assumptions Values
Amount of receivable, Japanese yen (¥)20,000,000
Spot exchange rate at time of sale (¥/$) 118.255
Competitor borrowing premium, yen (¥)2.0%
One-month forward rate (¥/$) 117.760 5.04%
Three-month forward rate (¥/$) 116.830 4.88%
One-year forward rate (¥/$) 112.450 5.16%
a. Alternative Hedges Values Certainty
1. Remain uncovered.
2. Forward market hedge.
Problem 10.7 Krystal
Krystal is a U.S.-based company which manufactures, sells, and installs water purification equipment. On April 11th the company sold a system to the City of
Nagasaki, Japan, for installation in Nagasaki’s famous Glover Gardens (where Puccini’s Madame Butterfly waited for the return of Lt. Pinkerton.) The sale was
priced in yen at ¥20,000,000, with payment due in three months.
Additional information: Aquatech’s Japanese competitors are currently borrowing yen from Japanese banks at a spread of 2 percentage points above the Japanese
money rate. Aquatech’s weighted average cost of capital is 16%, and the company wishes to protect the dollar value of this receivable.
Note: The interest rate differentials vary slightly from the forward discounts on the yen because of time differences for the quotes. The spot ¥118.255/$, for
example, is a mid-point range. On April 11, the spot yen traded in London from ¥118.30/$ to ¥117.550/$.
3. Money market hedge.
Account receivable (yen) 20,000,000
4. Put option hedge. (Need to sell yen = put on yen)
Option principal 20,000,000
Current spot rate (won/$) 118.255
Premium cost of option (%) 3.000%
Option pm (principal/spot rate x % pm) $5,073.78
The put option does not GUARANTEE the company of settling for the booked amount.
The money market and forward hedges do; the money market yielding the higher proceeds.
b) Breakeven rate between the money market and the forward hedge is determined by the reinvestment rate:
Caribou River’s Manadatory Forward Cover 0-90 days 91-180 days > 180 days
Paying the points forward
75% 60% 50%
Receiving the points forward
100% 90% 50%
Forward
Assumptions Values Discount
Spot rate, DKr/C$
4.70
South Face’s Exposures 0-90 days 91-180 days > 180 days
A/R due in 3 months, DKr
3,000,000
Analysis & Exposure Management
The Danish krone is selling forward at a discount versus the Canadian dollar: it takes more DKr/C$ forward.
Required Forward Cover for Compass Rose: 0-90 days 91-180 days > 180 days
A/R due in 3 months, DKr
75%
DKr Forward Cover
A/R due in 3 months, DKr
2,250,000
Problem 10.8 Caribou River
Caribou River, Ltd., a Canadian manufacturer of raincoats, does not selectively hedge its transaction exposure. Instead, if the date
of the transaction is known with certainty, all foreign currency-denominated cash flows must utilize the following mandatory
forward contract cover formula:
Caribou expects to receive multiple payments in Danish kroner over the next year. DKr 3,000,000 is due in 90 days; DKr 2,000,000
is due in 180 days; and DKr 1,000,000 is due in one year. Using the following spot and forward exchange rates, what would be the
amount of forward cover required by company policy by period?
4.71 -0.85%
4.72 -0.85%
4.74 -0.84%
Spot rate (T$/$) 33.40
3-month forward rate (T$/$) 32.40
Assumptions Values
Acquisition price & 3-month A/P, NewTaiwan dollars (T$) 7,000,000
Spot rate (T$/$) 33.40
Evaluation of Alternatives Cost Certainty
1. Do Nothing — Wait 3 months and buy T$ spot
If spot rate is the same as current spot rate 209,580.84$ Risky
2. Buy T$ forward 3-months
Assured cost of T$ at 3-month forward rate 216,049.38$ Certain
Problem 10.9 Pupule Travel
Pupule Travel, a Honolulu, Hawaii – based 100% privately owned travel company has signed an agreement to acquire a 50%
ownership share of Taichung Travel, a Taiwan – based privately owned travel agency specializing in servicing inbound
customers from the United States and Canada. The acquisition price is 7 million Taiwan dollars (T$ 7,000,000) payable in cash
in 3 months.
Thomas Carson, Pupule Travel’s owner, believes the Taiwan dollar will either remain stable or decline a little over the next 3
months. At the present spot rate of T$35/$, the amount of cash required is only $200,000 but even this relatively modest
Analyze the costs and risks of each alternative, and then make a recommendation as to which alternative Thomas Carson should
choose.
3. Money Market Hedge: Exchanging US$ for T$ now, depositing for 3-months until payment
Acquisition price in T$ needed in 3-months 7,000,000
Discounted back 3-months at T$ deposit rate 0.9963
Amount of NT$ needed now for deposit 6,973,848
Discussion.
This is a difficult decision. The forward contract appears to be the preferable choice, protecting him against an appreciating T$,
Current spot rate ($/€) $1.4158
Credit Suisse 90-day forward rate ($/€) $1.4172
Barclays 90-day forward rate ($/€) $1.4195
Mattel Toys WACC ($) 9.600%
90-day eurodollar interest rate 4.000%
Assumptions Values
90-day A/R (€) € 30,000,000.00
Current spot rate ($/€) $1.4158
Risk
Hedging Alternatives Values Assessment
1. Remain Uncovered, settling A/R in 90 days at market rate
(20 million euros / future spot rate)
2. Sell euros forward 90 days
3. Money Market Hedge
Problem 10.10 Mattel Toys
Mattel is a U.S.-based company whose sales are roughly two-thirds in dollars (Asia and the Americas) and one-third in euros
$1.4200/€ in 90 days. Mattel’s management does not use currency options in currency risk management activities. Advise Mattel on
which hedging alternative is probably preferable.
90-day euro borrowing rate 5.000%
Principal A/R in euros € 30,000,000.00
Evaluation of Alternatives
The money market hedge guarantees Mattel the greatest dollar value for the A/R when using the cost of capital as the reinvestment