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 ($/€) $1.4158
Credit Suisse 90-day forward rate ($/€) $1.4172
Barclays 90-day forward rate ($/€) $1.4195
Expected spot rate in 90 days ($/€)$1.4200
90-day eurodollar interest rate 4.000%
Risk
Hedging Alternatives Values Assessment
1. Remain Uncovered, settling A/R in 90 days at market rate
(20 million euros / future spot rate)
If spot rate in 90 days is same as current $42,474,000.00 Risky
If spot rate in 90 days is same as Credit Suisse forward rate $42,516,000.00 Risky
2. Sell euros forward 90 days
Settlement amount at Credit Suisse forward rate $42,516,000.00 Certain
3. Money Market Hedge
Principal A/R in euros € 30,000,000.00
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
(Europe). In September Mattel delivers a large shipment of toys (primarily Barbies and Hot Wheels) to a major distributor in
Antwerp. The receivable, €30 million, is due in 90 days, standard terms for the toy industry in Europe. Mattel’s treasury team has
collected the following currency and market quotes. The company’s foreign exchange advisors believe the euro will be at about
$1.4200/€ in 90 days. Mattel’s management does not use currency options in currency risk management activities. Advise Mattel on
which hedging alternative is probably preferable.
Evaluation of Alternatives
The money market hedge guarantees Mattel the greatest dollar value for the A/R when using the cost of capital as the reinvestment
rate (carry-forward rate).
Assumptions Values
Account recievable in 90 days (€) € 1,560,000
Initial spot exchange rate ($/€)$1.2224
Forward rate, 90 days ($/€)$1.2270
Expected spot rate in 90 to 120 days ($/€): Case #1 $1.1600
Expected spot rate in 90 to 120 days ($/€): Case #2 $1.2600
Hedged Hedged
If Chronos Time Pieces …… the Minimum the Maximum
Proportion of exposure to be hedged 70% 120%
Total exposure (€)€ 1,560,000 € 1,560,000
locking in ($) $1,339,884 $2,296,944
Case #1: Ending spot rate
Proportion uncovered (short) € 468,000 (€ 312,000)
If ending spot rate is ($/€)$1.1600 $1.1600
Value of uncovered proportion ($) $542,880 ($361,920)
Case #2: Ending spot rate
Proportion uncovered (short) € 468,000 (€ 312,000)
If ending spot rate is ($/€)$1.2600 $1.2600
value of uncovered proportion ($) $589,680 ($393,120)
Value of covered position (from above) 1,339,884$ 2,296,944$
Problem 10.11 Chronos Time Pieces
This is not a conservative hedging policy. Any time a firm may choose to leave any proportion uncovered, or purchase cover for more
than the exposure (therefore creating a net short position) the firm could experience nearly unlimited losses or gains.
Chronos Time Pieces of Boston exports wrist watches to many countries, selling in local currencies to watch stores and distributors.
Chronos prides itself on being financially conservative. At least 70% of each individual transaction exposure is hedged, mostly in the
forward market, but occasionally with options. Chronos’s foreign exchange policy is such that the 70% hedge may be increased up to a
120% hedge if devaluation or depreciation appears imminent. Chronos has just shipped to its major North American distributor. It has
issued a 90-day invoice to its buyer for €1,560,000. The current spot rate is $1.2224/€, the 90-day forward rate is $1.2270/€.
Chronos’s treasurer, Manny Hernandez, has a very good track record in predicting exchange rate movements. He currently believes the
euro will weaken against the dollar in the coming 90 to 120 days, possibly to around $1.16/€.
Construction payment due in six-months (A/P, Thai bhat) 28,200,000
Present spot rate (THB/HK$) 3.8800
Six-month forward rate (THB/HK$) 3.9800
What realistic alternatives are available for Wing Sang for making payments? Which method would you select and why?
What realistic alternatives are available to Wing Sang? Cost Certainty
1. Wait six months and make payment at spot rate
Highest expected rate 6,266,666.67$ Risky
2. Purchase Thai bhat forward six-months 7,085,427.14$ Certain
(A/P divided by the forward rate)
3. Transfer dollars to Thai bhat today, invest for six-months
Thai bhat needed today (A/P discounted 180 days) 27,851,851.85
Cost in Hong Kong dollars today (Thai bhat to Hong Kong dollars at spot rate) 7,178,312.33$
Problem 10.12 Wing Sang Jeans Limited
Wing Sang’s treasury manager, concerned about the overheating Thai economy, wonders if Wing Sang should be hedging its
foreign exchange risk. The manager’s own forecast is as follows:
Wing Sang Jeans Limited of Hong Kong is completing a new assembly plant near Bangkok, Thailand. A final construction
payment of THB28,200,000 is due in six months. (“THB” is the symbol for Thai baht.) Wing Sang uses 15% per annum as its
weighted average cost of capital. Today’s foreign exchange and interest rate quotations are as follows:
Spot Rate Forward Rate Days Forward
Date Event ($/£) ($/£) of Forward Rate
February 1 Price quotation for Pegg 1.7850 1.7771 210
March 1 Contract signed for sale 1.7465 1.7381 180
Contract amount, pounds £1,000,000
Analysis
a. The sale is booked at the exchange rate existing on June 1, when the product is shipped to Pegg Metropolitan, and the shipment
is categorized as an account receivable. This sale is then compared to that value in effect on the date of cash settlement,
the difference being the foreign exchange gain (loss).
b. The vlaue of the foreign exchange gain (loss) will depend upon when Jason actually purchases the forward contract. Because
many firms do not define an “exposure” as arising until the date that the product is shipped (loss of physical control over
the goods) and the sale is booked on the income statement, that is a common date for the purchase of the forward contract.
Forward contract purchased on June 1
Value of forward settlement 1 million pounds @ $1.7602/pound $1,760,200
Value as booked 1 million pounds @ $1.7689/pound $1,768,900
FX gain (loss) ($8,700)
A more aggressive alternative is for Jason to purchase the forward contract on the date that the contract was signed, March 1, locking–
in Burton’s U.S. dollar settlement amount a full 90 days earlier in the transaction exposure’s life span.
Problem 10.13 Burton Manufacturing
Jason Stedman is the director of finance for Burton Manufacturing, a U.S.-based manufacturer of hand-held computer systems for inventory
management. Burton’s system combines a low-cost active tag that is attached to inventory items (the tag emits a low-grade radio frequency) with
Assumptions Values
Shipment of phosphates from Morocco, Moroccan dirhams 6,000,000
Micca’s cost of capital (WACC) 14.000%
Spot exchange rate, dirhams/$ 10.00
Six-month forward rate, dirhams/$ 10.40
Risk Management Alternatives Values Certainty
1. Remain uncovered, making the dirham payment in six months
at the spot rate in effect at that date
Account payable (dirhams) 6,000,000
Possible spot rate in six months — the current spot rate (dirhams/$) 10.00
Cost of settlement in six months (US$) 600,000.00$ Uncertain.
2. Forward market hedge. Buy dirhams forward six months.
Account payable (dirhams) 6,000,000
3. Money market hedge. Exchange dollars for dirhams now, invest for six months.
Account payable (dirhams) 6,000,000.00
Discount factor at the dirham investing rate for 6 months 1.035
4. Call option hedge. (Need to buy dirhams = call on dirhams)
Option principal 6,000,000.00
Problem 10.14 Micca Metals, Inc.
Six-month call options on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar are available from Bank Al-
Maghrub at a premium of 2%. Six-month put options on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar are
available at a premium of 3%. Compare and contrast alternative ways that Micca might hedge its foreign exchange transaction
exposure. What is your recommendation?
Micca Metals, Inc. is a specialty materials and metals company located in Detroit, Michigan. The company specializes in specific
precious metals and materials which are used in a variety of pigment applications in many other industries including cosmetics,
appliances, and a variety of high tinsel metal fabricating equipment. Micca just purchased a shipment of phosphates from
Morocco for 6,000,000, dirhams, payable in six months.
Current spot rate, dirhams/$ 10.00
Premium cost of option 2.000%
Option premium (principal/spot rate x % pm) 12,000.00$
Assumptions Value
90-day A/R in pounds £3,000,000.00
Spot rate, US$ per pound ($/£)$1.7620
90-day forward rate, US$ per pound ($/£)$1.7550
3-month U.S. dollar investment rate 6.000%
3-month U.S. dollar borrowing rate 8.000%
3-month UK investment interest rate 8.000%
3-month UK borrowing interest rate 14.000%
Maria Gonzalez’s expected spot rate in 90-days, US$ per pound ($/£)$1.7850
Alternative #1: Remain Uncovered Rate ($/pound) Proceeds
Value of A/R will be (3 million pounds x ending spot rate ($/pound))
If spot rate is the same as current spot rate $1.7620 $5,286,000.00
If ending spot rate is the same as current forward rate $1.7550 $5,265,000.00
If ending spot rate is the expected spot rate $1.7850 $5,355,000.00
Alternative #2: Forward Contract Hedge Rate ($/pound) Proceeds
Sell the pounds forward 3-months locking in the forward rate
Pound A/R at the forward rate (pounds x forward) $1.7550 $5,265,000.00
Alternative #3: Money Market Hedge Rate ($/pound) Proceeds
Borrows against the A/R, receiving £ up-front, exchanging into US$.
Amount of A/R in 90-days, in pounds £3,000,000.00
Discount factor, pound borrowing rate, for 3-months 0.9662
Strike Rate ($/pnd) Strike Rate ($/pnd)
Alternative #4: Put Option Hedges 1.75 1.71
Option premium 1.500% 1.000%
Notional principal of option (pounds) £3,000,000.00 £3,000,000.00
Spot rate ($/pound) $1.7620 $1.7620
Option premium, US$ $79,290.00 $52,860.00
Ganado — the same U.S.-based company as discussed in this chapter, has concluded a second larger sale of telecommunications
equipment to Regency (U.K.). Total payment of £3,000,000 is due in 90 days. Maria Gonzalez has also learned that Ganado will only
be able to borrow in the United Kingdom at 14% per annum (due to credit concerns of the British banks). Given the following
exchange rates and interest rates, what transaction exposure hedge is now in Ganado’s best interest?
Problem 10.15 Maria Gonzalez and Ganado
Net proceeds from put options, in 90-days: Minimum $5,168,331.30 $5,075,554.20
Ending spot rate needed to be superior to forward: $1.7825 $1.7732
Proceeds from exchanging pounds for US$ spot $5,347,500.00 $5,319,600.00
Assumptions Values Today is June 1
90-day Forward rate, PHP/€PHP 56.1500 Exchange Rate
180-day Forward rate, PHP/€PHP 57.0500 Date (PHP/€)
Options on euros Strike (PHP/euro) Call Option Put Option
September maturity options PHP 56.0500 2.0% 1.5%
December maturity options PHP 56.0500 1.7% 1.1%
Valuation of Alternative Hedges September Receivable December Receivable
Amount of receivable, in euros € 2,500,000 € 2,500,000
a. Hedge in the forward market
Amount of receivable, in euros € 2,500,000 € 2,500,000
Respective forward rates (PHP/€)PHP 56.1500 PHP 57.0500
b. Hedge in the money market
Amount of receivable, in euros € 2,500,000 € 2,500,000
Discount factor for euro funds, period 1.0150 1.0300
Current proceeds from discounting, euros € 2,463,054 € 2,427,184
c. Hedge with options
Amount of receivable, in euros € 2,500,000 € 2,500,000
Buy put options for maturities (% x spot value) (PHP 2,101,875) (PHP 1,541,375)
Carry forward for the period 1.0500 1.0500
Premium cost carried forward to Dec 1 (PHP 2,206,969) (PHP 1,618,444)
4. Do nothing: ABB could wait until the sales proceeds were received in September and December, hope the recent strengthening of the euro would
Problem 10.16 ABB Group
1. Hedge in the forward market: The 3-month forward exchange quote was PHP56.1500/€ and the 6-month forward quote was PHP57.0500/€.
By the time the order was received and booked on June 1, the euro had strengthened to PHP56.0500/€, so the sale was in fact worth €5,000,000 ×
ABB Group. On May 1, ABB Group, a wholly owned subsidiary of Asia Power Generation Corporation (Philippines), sold a 20-megawatt
transformer to Roma Italia SpA of Italy for €5,000,000, payable as €2,500,000 on September 1 and €2,500,000 on December 1. ABB derived its
price quote of €5,000,000 on April 1 by dividing its normal Philippine peso sales price of PHP279,750,000 by the then current spot rate of
PHP55.9500/€.
ABB estimates the cost of equity capital to be 10% per annum. As a moderate-sized firm, ABB is unable to raise funds with long-term debt. Average
euro denominated government bonds yield 1.0% per annum. What should ABB do?
2. Hedge in the money market: ABB could borrow euros from the Munich branch of its Philippine bank at 6.00% per annum.
Total net proceeds, after premium deduction, Dec 1
d. Do nothing (remain uncovered)
Amount of receivable, in euros € 2,500,000 € 2,500,000
PHP 279,927,712.50
US Parent Company Sells Product to a Barcelona Subsidiary
Parameters Value
Sales price
2,000,000.00 €
Spot rate, day 0 (ZAR/€)
ZAR 16.4300 s
ZAR 17.8500
ZAR 15.9500
Cape Town P&L: No hedge Rate (ZAR/€) Entry
Payable as booked (initial spot) 16.4300 ZAR 32,860,000.00
Payable as settled (ending spot) 17.8500 ZAR 35,700,000.00
FX gain (loss) -ZAR 2,840,000.00
Cape Town P&L: Forward hedge Rate (ZAR/€) Entry
Payable as booked (initial spot) 16.4300 ZAR 32,860,000.00
Payable as settled (forward rate) 15.9500 ZAR 31,900,000.00
FX gain (loss) ZAR 960,000.00
Italian P&L: No Hedge Rate (ZAR/€) Entry
Receivable in Euro 2,000,000.00 €
A/R as invoiced in South African rand 16.4300 ZAR 32,860,000.00
A/R as settled at ending spot rate 17.8500 1,840,896.36 €
FX gain (loss) 159,103.64 €–
Italian P&L: Forward hedge Rate (ZAR/€) Entry
Receivable in Euro 2,000,000.00 €
A/R as invoiced in South African rand 16.4300 ZAR 32,860,000.00
A/R as settled at forward rate 15.9500 2,060,188.09 €
FX gain (loss) 60,188.09 €
Problem 10.17 Milan Pharmaceuticals SpA’s Intra-Company Hedging
Milan Pharmaceuticals SpA is an Italian multinationalthat has developed a vaccine for the Ebola virus. It recently established a
new subsidiary in Cape Town, South Africa, and is now in the process of establishing operating rules for transactions between
the Italian parent company and the Cape Town subsidiary. Alberto Fognini was International Treasurer for Milan and was
leading the effort at establishing commercial policies for the new subsidiary.
a) If the product was invoiced in euros, the parent has no direct exposure, but the South African subsidiary in Cape Town
does.
b) If the product was invoiced in South African rand, the Cape Town subsidiary has no exposure, but the Italian parent
company does.
a. Which unit would have suffered the gain (loss) on currency exchange if intra-company sales were invoiced in South African
rand (ZAR), assuming both completely unhedged and fully hedged?
b. Which unit would have suffered the gain (loss) on currency exchange if intra-company sales were invoiced in euros (€),
assuming both completely unhedged and fully hedged?
Uncovered Forward Cover Money Market Call Option
Payment (exposure) $30,000,000 $30,000,000 $30,000,000 $30,000,000
Effective ending rate (Won/$) 792 794 792 790
Current spot rate (Won/$) 800 800 800 800
Option premium (call) 2.900%
Bank Balance Uncovered Forward Cover Money Market Call Option
Beginning balance 25,000,000,000 25,000,000,000 25,000,000,000 25,000,000,000
Initial deductions 0 0 -23,645,320,197 -696,000,000
balance for interest 25,000,000,000 25,000,000,000 1,354,679,803 24,304,000,000
If exercised.
Pm 704,700,000
Total cost 23,760,000,000 23,820,000,000 23,940,886,700 24,404,700,000
Very Risky. Certain. Certain. Worst case.
Could be better.
How should KAL plan to make the payment to Boeing if KAL’s goal is to maximize the amount of won cash left in the bank at the end of the three month
period? Make a recommendation and defend it.
Problem 10.18 Korean Airlines
Korean Airlines (KAL) has just signed a contract with Boeing to purchase two new 747-400’s for a total of $60,000,000, with payment in two equal
tranches. The first tranche of $30,000,000 has just been paid. The next $30,000,000 is due three months from today. KAL currently has excess cash of
25,000,000,000 won in a Seoul bank, and it is from these funds that KAL plans to make its next payment.
The current spot rate is won 800/$, and permission has been obtained for a forward rate (90 days), won 794/$. The 90 day Eurodollar interest rate is
6.000%, while the 90 day Korean won deposit rate (there is no Euro-won rate) is 5.000%. KAL can borrow in Korea at 6.250%, and can probably borrow
in the U.S. dollar market at 9.375%.
A three month call option on dollars in the over-the-counter market, for a strike price of won 790/$ sells at a premium of 2.9%, payable at the time the
Eurodollar deposit rate
6.000%
US dollars for Payable
29,556,650$ ↔ ↔ 1.0150 ↔ ↔ 30,000,000$
↓
↓
↓
↓
↓
Korean bank balance
25,000,000,000
(23,645,320,197) Bank Balance at end
1,354,679,803 → → 1.0125 → → 1,371,613,300
Korean Airlines Money Market Hedge
The challenge with the Korean Money Market Hedge is that it is a payable — a payable form a Korean won cash balance. A
MM Hedge for a payable is to simply transfer money into the target currency at the start of the period (the front end of the
box), and then to have that money earn interest on deposit for the time period until payment is due.