Blades, Inc.

Case

Chapter Two

1. A higher level of inflation in Thailand would most likely affect Blades in a positive manner. Generally, if a countrys inflation increases it drives the consumers and corporations of that country to buy more goods overseas, thus Blades sales should 2. Anticipated inflation favors Blades. If the inflation in Thailand increases both, the U.S. and Thailand firms would be forced to raise their prices in order to maintain the profit margin. Since Blades cost of goods sold in Thailand is relatively small, it should not be affected as much by the inflation. This means that Blades should not have to raise prices as much as the competitors, putting Blades in a favorable position. 3. Decreasing level of national income in Thailand would negatively impact Blades. Local consumers will have less money to spend. In addition, because Blades product is not a necessity but a leisure-product, the demand for it will drastically decrease. There is also a chance that the importer may terminate the future arrangements due to the poor 4. Continued depreciation in baht would negatively impact Blades because Blades invoices its product in this currency. Baht denominated revenue will consequently be converted in fewer U.S. dollars. However, the demand for Blades products might be positive in comparison to the U.S. competitors in Thailand. The U.S. competitors that export their roller-blades to Thailand invoice their products in the U.S. dollars. In order to pay for the dollar denominated products the importers will have to convert more baht to dollars, thus making demand for Blades products increase in comparison to the U.S. competitors.

Blades, Inc. Case 5

1. The possible options are: 1) Option 1 with the exercise price of $0.00756; the exercise price is 5% above the spot rate; pay the premium that has increased to 2% of the exercise price (the option premium is higher than what the company desires to pay). 2) Option 2 with the exercise price of $0.00792; exercise price is 10% above the spot rate; pay the premium of 1.5%. From the given choices one can see that the tradeoff exists between paying a higher premium or a higher exercise price. In my opinion, Blades should choose option 1. Paying a higher exercise price limits the cause of a hedge. In addition, it would benefit Blades more to pay a premium of $1,890 in order to limit the payables to $94,500. 2. In my opinion it should not. Given the historical data that suggests that there will most likely be a decrease in a current spot rate, the volatile movements, and the recent event that caused uncertainty about the yens future value, it would be vise to hedge. Another alternative would be to consider future contracts. This is viable because the spot rate or the futures rate of the yen did not change after the event. Blades can lock in its future payment at the price same as before the event. 3. $0.006912. The futures rate is equal to the expected spot rate at the delivery date. 4. The best choice would be to buy a futures contract. The cost on the delivery date is the same as remaining unhedged and it equals $86,400, however, not hedging in this case, is not as logical option because of the possible yen fluctuation between the order date and the delivery date. Given the other things remain constant this is the most cost efficient solution (see spreadsheet).

Question 4

Remain unhedged amount in yen expected spot rate cost after 2 months 12,500,000 0.006912 86,400

Buy one futures contract amount in yen futures price per yen cost after 2 months 12,500,000 0.006912 86,400

Buy two options amount in yen exercise price premium per yen

Option 1 6,250,000 0.00756 0.0001512

Option 2 6,250,000 0.00792 0.0001134

2 x Option 1 2 x Option 2 Options 1 & 2 Total premium in yen exercise price cost after 2 months 1,890 86,400 88,290 1,417.50 86,400 87,817.50 1653.75 86,400 88,053.75

Question 6 Expected spot rate Remain unhedged amount in yen expected spot rate cost after 2 months 12,500,000 0.007912 98,900 Standard deviation 0.006912 0.0005

Spot rate 2 S.D. increase 0.007912

Buy one futures contract amount in yen futures price per yen cost after 2 months 12,500,000 0.006912 86,400

Buy two options amount in yen exercise price premium per yen

Option 1 6,250,000 0.00756 0.0001512

Option 2 6,250,000 0.00792 0.0001134

2 x Option 1 2 x Option 2 Options 1 & 2 Total premium in yen exercise price cost after 2 months 1,890 94,500 96,390 1,417.50 98,900 100,317.50 1653.75 96,700 98,353.75

Blades, Inc. Case 8

1. The inflation-exchange relationship can be found in the PPP theory. The theory suggests that the currency of the country with the higher inflation rate should depreciate to compensate the inflation differential. High levels of inflation in Thailand should cause baht to depreciate since it is a freely floating currency. Because of the export deal Blades has struck, it is unable to alter its prices so they go in line with the level of inflation. Therefore Blades revenue would be negatively affected. Blades costs will increase as Thai exporters adjust their prices to inflation.

Blades exports are baht-denominated thus baht depreciation will lead to a conversion of baht into fewer dollars. However, according to the PPP the baht depreciation should counter high levels of inflation therefore creating an impact on the high prices. The net effect of this relationship on Blades is negative. 2. Factors that prevent PPP from occurring in the short run are: relative interest rates, government regulations, national income, lack of proper substitute products, etc. The reason being is that the exchange rates are impacted by factors other than the inflation. PPP will not hold if countries negotiate trade arrangements under which they commit themselves to the purchase or sale of a fixed number of goods over a specified period of time. At lest it will not hold in the short run. The logic behind this statement is that there will be a setback on the impact of inflation, and thus the exchange rates because of the committed trade arrangements that are not easily terminated due to the legal power of a contract.

Blades, Inc. Case 9

1. There are several ways Blades can benefit. Blades generates baht-denominated cash inflows and then converts them to U.S. dollars. Forecasting the exchange rate may allow Blades to make hedging decisions. Furthermore, it is mentioned that Blades may establish a subsidiary in Thailand. If this was to happen, profits earned by this subsidiary will be in baht. These earnings will then be sent back to the parent or reinvested in Thailand. In both scenarios forecasting exchange rate is vital for companys future. 2. A market-based forecast is the easiest to use because it is based on either spot rate or the

forward rate. In this case it would be better to use forward rates. 3. The forward rates would yield a better market-based forecast. It is said that the available forward rates currently exhibit a large discount, which implies higher interest rate, which then implies higher inflation. Higher inflation is associated with a downward pressure on the baht, which is a valid forecast. Using the present spot rate to forecast future spot rate would mean that the value of the baht would not fluctuate, which is not likely to happen. 4. market-based forecast By using the forward rate market-based forecast it is shown that baht is expected to change by -8.70 percent. The value of the baht in 90 days according to this forecast will -0.08696 be $0.021. 5. Weekly accuracy of technical forecast indicates market inefficiency for the baht-dollar exchange rates. Technical forecasting involves the use of historical exchange rate data to predict future rates and mostly apply to very shot-term periods such as one day. Given the conditions Thailand is in, examination of past movements will not be useful for indicating future rates. 6. fundamental forecast The expected change using the fundamental forecast is -6.85 percent. -0.0685 forecasted value of the baht The forecasted value of the baht using the expected value as the forecast is $.0214.

absolute error- technical forecasting absolute error- fundamental forecasting absolute error- market-based forecasting 0.021425 -0.01727 -0.02614 -0.04545 The absolute forecast errors are as follows: technical forecasting 1.73%; fundamental forecasting 2.61%; and the market-based forecast 4.54%. Observing given forecasting techniques and their absolute errors the conclusion arises that the most accurate technique is the technical forecasting. 7. It will not. As mentioned earlier, technical forecasting involves the use of historical exchange rate data to predict future rates. Examination of past movements will most likely not be as useful for indicating future rates in Thailand. There are a lot of uncertainties when it comes to exchange rates in this country. There is a high volatility of the baht-dollar exchange rate. In addition, Thai economy is experiencing unfavorable conditions that will have an affect on exchange rates.

Blades, Inc. Case 10

1. Blades is subject to transaction and economic exposure. Transaction exposure is the exposure of an organizations contractual transactions to exchange rate movements. Economic exposure is any exposure of a companys cash flows to exchange rate movements.

2. See attached spreadsheet. 3. It will reduce Blades transaction exposure. The reason being is that if the dollar revenue is decreased due to baht depreciation, the dollar cost will also decrease due to the depreciation of yen (Blades generates baht-denominated net inflows, but its outflows are yen-denominated). 4. I dont think it should. Blades only way of reducing its net transaction exposure lies in importing from Japan due to the high correlation level between baht and yen. It is less likely that the correlation between these two currencies will last for the extended period of time. The correlation has been low in the past and will most likely return to its normal state in the future. 5. The transaction exposure will have a slight increase. In this scenario two factors impact transaction exposure. Firstly, Blades net cash inflows would be denominated in foreign currencies driving the transaction exposure upwards. Secondly, the correlation between baht and yen on one side, and British pound on the other, is not significantly high. This means that changes in one currency (BP) may not drastically affect the other (baht).

Currency British pound Japanese yen Thai baht

inflow 16,000,000

outflow

net inflow-outfllw 16,000,000

expected exchange rate 1.5 0.0083 0.024

12,648,000 826,920,000 206,712,000

12,648,000 620,208,000

Currency British pound Japanese yen

net inflow-outflow 16,000,000 12,648,000

possible e.r. range from possible e.r. range to 1.47 0.0079 1.53 0.0087

range in U.S. $ from 23,520,000.00 99,919.20

Thai baht

620,208,000

0.020

0.028

12,404,160.00

Blades, Inc. Case 11

1.

baht baht Forward Hedge Revenue Forward rate 152,730,000 0.0215

Outflow (90 days)

54,000,000

Net inflow (outflow) 152,730,000

Dollars to be received (90 days) 3,283,695

Money Market Hedge Ammount borrowed (baht) Dollars from converting baht Dollars accumulated (90 days) 146,855,769 3,377,683 3,448,614

Stay Unhedged Probability 5% 20 30 25 15 5 Spot rate 0.2000 0.0213 0.0217 0.0220 0.0230 0.0235 Dollars from converting baht 3,054,600 3,253,149 3,314,241 3,360,060 3,512,790 3,589,155

The best option would be to use the money market hedge.

2.

BP BP BP Forward Hedge Revenue Forward rate 4,000,000 1.49

Inflow (90 days) Outflow (90 days)

4,000,000

Net inflow (outflow) 4,000,000

Dollars to be received (90 days) 5,960,000

Money Market Hedge Ammount borrowed (BP) Dollars from converting BP Dollars accumulated (90 days) 3,921,569 5,882,353 6,005,882

Stay Unhedged Probability 5% 20 30 25 15 5 Spot rate 1.4500 1.4700 1.4800 1.4900 1.5000 1.5200 Dollars from converting baht 5,800,000 5,880,000 5,920,000 5,960,000 6,000,000 6,080,000

The best option would be to use the market hedge.

3. It is easier for Blades to hedge its inflows denominated in foreign currencies. The reason

being that Blades outflows are impacted by payables denominated in foreign currencies

and the future exchange rate, while the dollar inflows are impacted only by the exchange

rates.

4. None of the hedges would require Blades to over-hedge. In addition, Blades is not subject

to over-hedge with a money market hedge. The arrangements with Thai and British

companies are using fixed prices.

5. Blades could modify the timing in order to reduce its transaction exposure. The way

Blades can do this is by importing materials in order to manufacture 68,910 pairs of

Speedos (quarterly revenue / cost per pair of Speedos). The Thai customer can then make

a direct payment to the Thai supplier. The tradeoff of this modification is that in order to

reduce transaction exposure for this quarter, Blades sacrifices transaction exposure for the

future, making it higher. In addition, Blades will have to deal with excess inventory.

6. Blades could modify the payment practices to reduce its transaction exposure. Blades

has a policy of paying Thai imports upon a day of delivery in order to maintain a good

trade relationship. This means that Blades pays the suppliers 60 days ahead of the

allowed period. Any currency changes in this period could affect Blades. The tradeoff

would be that Blades will not be able to use baht-denominated costs to balance its baht-

denominated revenues.

7. Given all the conditions, Blades could benefit from long-term forward contracts for

both baht and BP, agree to a parallel loan, or swap currencies. The reason being is that

long-term hedging is possible for companies that can estimate their foreign currency

receivables and payables.

Blades, Inc.

Case 12

1. Blades would be negatively affected in several ways. Firstly, if the commitment is

renewed the agreed prices would be fixed. In addition, high level of inflation would

cause baht to depreciate, thus decreasing the dollars gained from baht-denominated

sales. Finally, the costs of goods sold in Thailand would be negatively impacted by the

2. With the current conditions it is less likely that Thai importer will renew its commitment.

The reason being - negative economical effects. With the high inflation and possibility

of baht depreciating, Thai customers will be less willing to spend money on leisure

products. However, if the economy returns to the high growth level, Thai importer will

more likely want to renew the deal. The importer will be confident in the future sales.

3. 0.022 Sales U.S. Thai British Total 1.53 62,400,000 18,192,240 24,480,000 105,072,240 0.0209 1.485 62,400,000 17,282,628 23,760,000 103,442,628 0.0198 1.5 62,400,000 16,373,016 24,000,000 102,773,016 baht BP

Cost U.S. Thai Total 57,400,000 5,280,000 62,680,000 57,400,000 5,016,000 62,416,000 57,400,000 4,752,000 62,152,000

Expenses

U.S. Fixed U.S. Variable Total CF before taxes

2,000,000 6,864,000 8,864,000 33,528,240

2,000,001 6,864,000 8,864,001 32,162,627

2,000,002 6,864,000 8,864,002 31,757,014

Blades doesnt seam to be impacted much by the high level of economic exposure. 4. 0.022 Sales U.S. Thai British Total 1.5 62,400,000 18,192,240 24,000,000 104,592,240 0.0209 1.425 62,400,000 17,282,628 22,800,000 102,482,628 0.0198 1.35 62,400,000 16,373,016 21,600,000 100,373,016 baht BP

Cost U.S. Thai Total 57,400,000 5,280,000 62,680,000 57,400,000 5,016,000 62,416,000 57,400,000 4,752,000 62,152,000

Expenses U.S. Fixed U.S. Variable Total 2,000,000 6,864,000 8,864,000 2,000,000 6,864,000 8,864,000 31,202,628 2,000,000 6,864,000 8,864,000 29,357,016

CF before taxes 33,048,240

Here we can see that if baht and BP are perfectly correlated Blades would be exposed to

increasing level of economic risk. The main reason is that Blades generates its inflows in

both currencies. A depreciation of both currencies would have a more significant affect

on Blades cash flows before taxes.

5. Blades can choose to do several things to reduce its level of economic exposure to

Thailand. One option would be to diversify the selection of countries to do business

with. By incorporating countries that have insignificant correlation to each other, Blades

reduces its economic exposure. Furthermore, Blades can engage in buying supplies in

Thailand, thus creating more cash outflows in baht. Blades could borrow in baht, pay off

baht-denominated loans, and convert baht to dollars to pay U.S. supplies. Finally, Blades

could borrow in baht, pay off baht-denominated loans, and convert baht to dollars to pay

U.S. supplies.

Blades, Inc.

Case 13

1. Given the current situation, there are several things that would factor in a positive

DFI. Firstly, Blades generates higher profit margin in Thailand. In addition, the cost of

materials is significantly cheaper in Thailand. DFI in Thailand would diversify the risk.

In other words, Blades would not be solely reliant on the U.S. economic conditions.

Finally, Blades would increase its overall market share.

2. The main tradeoff is between the initial outlay required to invest and operating under

uncertain economic conditions. If Blades was to engage in DFI now, the initial outlay

will be low. However, the primary concern is that Thai consumers have not been affected

yet by the unfavorable economic conditions, and the possibility that the economic

conditions will not improve in the future. If this was to happen, Blades would pay a price.

Nevertheless, If Blades waits one year and economy improves, the initial outlay required

would be high, and there is a change there might be heavier competition. As a financial

consultant for Blades, I would advise a scenario analysis, as well as the series of other

financial analysis (applying various ratios, etc.) prior to making this decision. Scenario

analysis would be useful because we can see the possible outcomes and the changes

for worst, best, and average situation. We could go from there. Based on the current

situation, however, I would advise Ben Holt to wait with the DFI.

3. Again the main tradeoff is profits versus the risk of poor economic conditions. If Blades

renews the agreement with the retailer for another 3 years, it will tie itself to relatively

low prices it charges the Thai retailer. If economic conditions improve, there would be

an expected increase in the demand for Blades products. Blades would generate higher

profit margins if decided to enter the market through the subsidiary, or construct a more

favorable deal with another retailer. On the other hand, if economic conditions continue

to worsen, the agreement would be profitable for Blades. Again I believe that a set of

financial analysis are needed prior to making this decision.

4. Given all the conditions mentioned, Thai government would have to consider the impact

of Blades subsidiary on the employment, as well as the impact of Blades subsidiary

to local businesses. Generally, Blades (and companies likes Blades) could reduce

the unemployment rate if they were to commit to employ local workers. However,

Thai government should be concerned about the local businesses. In the long run,

companies like Blades could run Thai competitors out of business, thus increasing the

unemployment even more. In reality, it all depends on the government policy to allow

foreign investments. I believe that Thai government would most likely welcome MNCs

subsidiaries in order to deal with the unemployment in a short run. Another promising

solution would be possible mergers and acquisitions.

Blades, Inc.

Case 14

1. In the given scenario, sales from the existing agreement should not be included in the

capital budgeting analysis. The reason being is that Blades would have these sales with

or without the subsidiary in Thailand. The cost savings for the pairs not sourced from

Thailand should be included because these sales would not happen if Blades continued

to import from Thailand. Finally, the sales resulting from a renewed agreement should be

included in the capital budgeting analysis because this revenue is incremental to creating

2. See spreadsheet. Blades should establish the subsidiary in Thailand under the given

conditions. The capital budgeting analysis shows a positive NPV if Blades renews the

agreement with Entertainment Products and establishes the subsidiary

3. See spreadsheet. The capital budgeting analysis indicates that Blades should establish a

subsidiary and not renew its agreement. The NPV was $8,746,688

4. See spreadsheet. The salvage value is not that critical. The capital budgeting analysis in

question 2 is the most feasible alternative. As spreadsheet suggests (comparing question

3 and question 4), even if Blades salvage value is reduced to 0 (Blades does not sell the

subsidiary), the NPV remains positive.

5. See spreadsheet. The capital budgeting analysis shows a positive NPV of $5,620,315 for

the worst case scenario. Therefore, Blades should establish the subsidiary even if baht

depreciates by 5 percent annually.