Transaction Exposure
Short Description
Transaction Exposure...
Description
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;283ee( to bu' :on call on :on
Cption principal .urrent spot rate 4won/5 're!iu! cost o$ option 4ee( to sell 'en put on 'en Cption principal .urrent spot rate 4won/5 're!iu! cost o$ option 4 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
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 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
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