Chapter 8

Problem 11.
1 Siam Cement
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?
Assumptions Value
US dollar debt taken out in June 1997 $ 50,000,000
US dollar borrowing rate on debt 8.400%
Initial spot exchange rate, baht/dollar, June 1997 25.00
Average spot exchange rate, baht/dollar, June 1998 42.00
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
Exchange rate at time of repayment, baht/dollar 25.00

Total repayment in Thai baht 1,355,000,000
Total proceeds from loan, up-front, in Thai baht 1,250,000,000
Net interest to be paid, in Thai baht 105,000,000
Actual Repayment:
Repayment of US dollar debt: Principal $ 50,000,000
Repayment of US dollar debt: Interest 4,200,000
Total repayment $ 54,200,000
Exchange rate at time of repayment, baht/dollar 42.00

Total repayment in Thai baht 2,276,400,000
Less what Siam had EXPECTED or SCHEDULED to be repaid (1,355,000,000)
Amount of foreign exchange loss on debt in baht 921,400,000
Problem 11.2 Hindustan Lever
Unilever’s affiliate in India, Hindustan Lever, 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. Hindustan Lever 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 Hindustan Lever 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.
Assumptions Values
180-day account payable, Japanese yen (¥) 8,500,000
Spot rate (¥/$) 120.60
Spot rate, rupees/dollar (Rs/$) 47.75
Implied (calculated) spot rate (¥/Rs) 2.5257 (120.60 / 47.75)
180-day forward rate (¥/Rs) 2.4000
Expected spot rate in 180 days (¥/Rs) 2.6000
180-day Indian rupee investing rate 8.000%
180-day Japanese yen investing rate 1.500%
Currency agent's exchange rate fee 4.850%
Hindustan Lever's cost of capital 12.00%
Spot Risk
Hedging Alternatives Values Rate (Rp/$) Assessment
1. Remain Uncovered, settling A/P in 180 days at spot rate
If spot rate in 180 days is same as current spot (Rs) 3,365,464.34 2.5257 Risky
If spot rate in 180 days is same as forward rate (Rs) 3,541,666.67 2.4000 Risky
If spot rate in 180 days is expected spot rate (Rs) 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
discount factor for yen investing rate for 180 days 0.9926 1/(1 + (.015 x 180/360))
Principal needed to meet A/P in 180 days (¥) 8,436,724.57 $8,436,489.78 this is just a PV function
Current spot rate (¥/Rs) 2.5257

Indian rupee, current amount (Rs) 3,340,411.26
Hindustan Lever's WACC carry-forwad factor for 180 days 1.0600 1/(.12 x 180/360) 0.06 cost of capital for 180 days
Future value of money market hedge (Rs) 3,540,835.94 Certain 3540836 cost
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
Plus agent's fee (4.850%) 163,225.02

Hindustan's WACC carry-forwad factor for 180 days on fee 1.0600 1/(.12 x 180/360)
Total future value of agent's fee (Rs) 173,018.52
Total A/P, future value, A/P + fee (Rs) 3,538,482.87 Certain
Evaluation of Alternatives
The currency agent is the lowest total cost, in CERTAIN future rupee value, of all certain alternatives.
b. To hedge 120% of an exposure means that you are in effect hedging 100% of the exposure, and then taking an open speculative position on an
additional amount of 20% of the original exposure amount. The two positions need to be separated and evaluated independently. Hedging more than
100% of an exposure always means that a speculative position is being taken. For that reason, many firms have foreign exchange management
policies which prohibit hedging more than 100%.
c. The most conservative policy for a firm would be to limit all hedges to 100%, or even less. Many firms hedge slightly less than 100% in order to
allow themselves a small margin of error in case the actual exposure size was slightly over-estimated.
Problem 11.3 Seattle Scientific, Inc.
Josh Miller is chief financial officer of a medium-sized Seattle-based medical device manufacturer. The
company’s annual sales of $40 million have been growing rapidly, and working capital financing is a common
source of concern. He has recently been approached by one of his major Japanese customers, Yokasa, with a
new payment proposal. Yokasa typically orders ¥12,500,000 in product every other month and pays in Japanese
yen. The current payment terms extended by Seattle are 30 days, with no discounts given for early or cash
payment. Yokasa has suggested that it would be willing to pay in cash – in Japanese yen – if it was given a
4.5% discount on the purchase price. Josh Miller gathered the following quotes from his bank on current spot
and forward exchange rates, and estimated Yokasa’s cost of capital.
Assumptions Values
Seattle's 30-day account receivable, Japanese yen 12,500,000
Spot rate, ¥/$ 111.40
30-day forward rate, ¥/$ 111.00
Yokasa's WACC 8.850%
Seattle Scientific's WACC 9.200%
Desired discount on purchase price by Yokasa 4.500%
Josh Miller 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

Discount for cash payment up-front (4.500%) (562,500)
Amount paid in cash net of discount 11,937,500
Current spot rate 111.40

Amount received in U.S. dollars by Seattle Scientific $ 107,158.89
2. Not offer any discounts for early payment and cover exposure with forwards
Account receivable (yen) 12,500,000

30-day forward rate 111.00
Amount received in cash in dollars, in 30 days $ 112,612.61
Discount factor for 30 days @ Seattle's WACC 0.9924

Present value of dollar cash received $ 111,755.82
Josh Miller should politely decline Yokasa's offer to pay cash in exchange for the requested discount.
Problem 11.4 Warner Indonesia
Warner, the 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 minimum gross margin, in
this case, a cash settleemnt of $168,000. The current 90-day forward rate is Rp9,950/$. Although this rate appeared
unattractive, Warner had to contact several major banks before even finding a forward quote on the rupiah. The
consensus of currency forecasters at the moment, however, is that the rupiah will hold relatively steady, possibly
falling to Rp9,400/$ over the coming 90 to 120 days. Analyze the prospective sale and make a hedging
recommendation.
Assumptions Values At Spot

Receivable due in 3 months, in Indonesian rupiah (Rp) Rp1,650,000,000 $174,603.17
Spot rate (Rp/$) 9,450
Expected spot rate in 90 days (Rp/$) 9,400
3-month forward rate (Rp/$) 9,950
Minimum dollar amount acceptable at settlement $168,000.00
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

(Rp1,650,000,000 / Rp9,450/$
If spot rate in 90 days is Rp9,400/$ $175,531.91 Risky

(Rp1,650,000,000 / Rp9,400/$)
If spot rate in 90 days is Rp9,950/$ $165,829.15 Risky

(Rp1,650,000,000 / Rp9,950/$)
2. Sell Indonesian rupiah forward.
A/R sold forward 90 days $165,829.15 Certain
"Cost of cover" is the forward discount on Rp -20.1%
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.
Unfortunately, the forward contract does not result in dollar proceeds which meet the minimum margin.
The cost of forward cover, 20.1%, is indicative of the "artificial interest rates" used by some financial
institutions while pricing derivatives in emerging, illiquid, and volatile markets.
In the end, Warner will have to decide whether making the sale into this specific market is worth breaking a
company policy on minimum proceeds (forward cover) or taking significant currency risk by not using
forward cover.
Problem 11.5 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.
Assumptions Values
Receivable due in one year, US dollars $80,000,000
Payable due in one year, US dollars $20,000,000
Spot rate, reais per dollar (R$/$) 1.8240
One-year US dollar eurocurrency interest rate 4.00%
One-year Brazilian govt deposit note 10.50% Spot rate, reais per dollar (R$/$) X ( 1 + One-year Brazilian govt deposit note)/(1+One-year Brazilian govt deposit note)
Implied one year forward rate = spot x ( 1 + iR$ ) / ( 1 + i$ ) 1.9380 D20*(1+D22)/(1+D21)
Risk
Analysis Values Assessment
Net exposure at time of cash settlements:
One year A/R due $80,000,000

One year A/P due ($20,000,000)
Net exposure $60,000,000 Certain
This is a net long position, meaning, Embraer will be receiving US dollars on net. Given the history of the Brazilian reais, that
it has traditionally suffered from rapid depreciation and occasional devaluation, a net long position in dollars by most
Brazilian companies is considered a very good thing.
Cash settlement of the net position:
Brazilian reais in one year at current spot rate R$ 109,440,000.00 Risky
Brazilian reais in one year at one year forward rate R$ 116,280,000.00 Certain
In this case, however, because the reais is selling forward at a considerable discount, the net long position -- if sold forward --
yields considerably more reais than the current spot rate. It should also be noted, however, that if the reais were to fall
considerably over the coming year, by remaining unhedged Embraer would enjoy greater reais returns.
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Problem 11.6 Caterpillar
Caterpillar (U.S.) just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was
Won7,030 million. Won1,000 million has already been paid, and the remaining Won6,030 million is due in six months. The current spot
rate is Won1200/$, and the 6-month forward rate is Won1260/$
Caterpillar can invest at the rates given above, or borrow at 2% per annum above those rates. Caterpillar's weighted average cost of
capital is 10%. Compare alternate ways that Cat might deal with its foreign exchange exposure. What do you recommend and why?
Assumptions Values
Purchase price of Korean manufacturer, in Korean won 7,030,000,000
Less initial payment, in Korean won (1,000,000,000)
Net settlement needed, in Korean won, in six months 6,030,000,000
Current spot rate (Won/$) 1,200
Six month forward rate (Won/$) 1,260
Plasti-Grip's cost of capital (WACC) 10.00%
Options on Korean won: Call Option Put Option

Strike price, won 1,200.00 1,200.00
Option premium (percent) 3.000% 2.400%
United States Korea

Six-month investment (not borrowing) interest rate (per annum) 4.000% 16.000% these are yealry
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) 6,030,000,000
Possible spot rate in six months: current spot rate (won/$) 1,200
Cost of settlement in six months (US$) $ 5,025,000.00 Uncertain.

Possible spot rate in six months: forward rate (won/$) 1,260
Cost of settlement in six months (US$) $ 4,785,714.29 Uncertain.
2. Forward market hedge. Buy won forward six months

Forward rate (won/$) 1,260.00
Cost of settlement in six months (US$) $ 4,785,714.29 Certain.
3. Money market hedge. Exchange dollars for won now, invest for six months.

Discount factor at the won interest rate for 6 months 1.080
Won needed now (payable/discount factor) 5,583,333,333.33 this is just the PV ($5,583,333,333.33)
Current spot rate (won/$) 1,200.00
US dollars needed now $ 4,652,777.78 use the Wacc
Carry forward rate for six months (WACC) 1.050 this is just the FV ($4,885,416.67)
US dollar cost, in six months, of settlement $ 4,885,416.67 Certain.
4. Call option hedge. (Need to buy won = call on won)

If exercised If not exercised
Option principal 6,030,000,000
Current spot rate (won/$) 1,200.00 1,307.00 ??? whatever you believe
Premium cost of option (%) 3.000%
Option premium (principal/spot rate x % pm) $ 150,750.00
If option exercised/not exercised, dollar cost of won $ 5,025,000.00 $ 4,613,618.97

Premium carried forward six months (pm x 1.125, WACC) 158,287.500 158,287.50
Total net cost of call option hedge if exercised $ 5,183,287.50 $ 4,771,906.47
Maximum.
The forward contract provides the lowest CERTAIN cost hedging method for payment settlement. If, however, the firm believes the
ending spot rate will be a weaker Won, Won1,307/$ or higher, then the call option would be a lower cost alternative. This would require,
however, that the firm accept foreign exchange risk and be willing to suffer the higher cost of the call option in the event that the Won
did not fall to the needed level.
Problem 11.7 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
$1.4200/€ in 90 days. Mattel’s management does not use currency options in currency risk management activities. Advise Mattel
on which hedging alternative is probably preferable.
Assumptions Values
90-day A/R (€) € 30,000,000.00
Current spot rate ($/€) $1.4158
Credit Suisse 90-day forward rate ($/€) $1.4172
Barclays 90-day forward rate ($/€) $1.4195
Expected spot rate in 90 days ($/€) $1.4200
90-day eurodollar interest rate 4.000%
90-day euro interest rate 3.885%
Implied 90-day forward rate (calculated, $/€) $1.4162
90-day eurodollar borrowing rate 5.000%
90-day euro borrowing rate 5.000%
Mattel Toys weighted average cost of capital ($) 9.600%
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
If spot rate in 90 days is same as Barclays forward rate $42,585,000.00 Risky
If spot rate in 90 days is expected spot rate $42,600,000.00 Risky
2. Sell euros forward 90 days
Settlement amount at Credit Suisse forward rate $42,516,000.00 Certain
Settlement amount at Barclays forward rate $42,585,000.00 Certain

Principal A/R in euros € 30,000,000.00
discount factor for euro borrowing rate for 90 days 0.9877 1/(1 + (.05 x 90/360))
Borrow euros against 90-day A/R € 29,629,629.63
Current spot rate, $/euro $1.4158

US dollar current value $41,949,629.63
Mattel's WACC carry-forward factor for 90 days 1.0240 1 + (.0960 x 90/360)
Future value of money market hedge $42,956,420.74 Certain
Evaluation of Alternatives
The money market hedge guarantees Mattel the greatest dollar value for the A/R when using the cost of capital as the reinvestment
rate (carry-forward rate).
Problem 11.8 South Face
South Face, Ltd., a Canadian manufacturer of raincoats, does not selectively hedge its transaction exposure. Instead, if the date of
the transaction is known with certainty, all foreign currency-denominated cash flows must utilize the following mandatory forward
contract cover formula:
South Face's Manadatory Forward Cover 0-90 days 91-180 days > 180 days
Paying the points forward 75% 60% 50%
Receiving the points forward 100% 90% 50%
South Face expects to receive multiple payments in Danish kroner over the next year. DKr 3,000,000 is due in 90 days; DKr
2,000,000 is due in 180 days; and DKr 1,000,000 is due in one year. Using the following spot and forward exchange rates, what
would be the amount of forward cover required by company policy by period?
Forward
Assumptions Values Discount
Spot rate, DKr/C$ 4.70
3-month forward rate, DKr/C$ 4.71 -0.85%
South Face's Exposures 0-90 days 91-180 days > 180 days
A/R due in 3 months, DKr 3,000,000
A/R due in 12-months, DKr 1,000,000
Analysis & Exposure Management

The Danish krone is selling forward at a discount versus the Canadian dollar: it takes more DKr/C$ forward.
South Face is receiving foreign currency, DKr, at future dates ("long DKr").
South Face is therefore expecting to PAY THE POINTS FORWARD.
Required Forward Cover for Northern: 0-90 days 91-180 days > 180 days
A/R due in 3 months, DKr 75%
A/R due in 6 months, DKr 60%
A/R due in 12-months, DKr 50%
DKr Forward Cover

A/R due in 12-months, DKr 500,000
Expected Canadian dollar value of DKr sold forward 477,707.01 254,237.29 105,485.23
Problem 11.9 Translucent/H2O
Translucent/H2O is a U.S.-based company which manufactures, sells, and installs water purification equipment. On April 20th 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: Translucent/H2O’s Japanese competitors are currently borrowing yen from Japanese banks at a spread of 2
percentage points above the Japanese money rate. Translucent/H2O's weighted average cost of capital is 16%, and the company
wishes to protect the dollar value of this receivable.
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
Booked value of sale (amount/spot rate) $169,126.04
Days receivable due 90
Translucent/H2O's WACC 16.0%
Competitor borrowing premium, yen (¥) 2.0%
Forward rates and premiums Forward Rate Premium

One-month forward rate (¥/$) 117.760 5.04%
Three-month forward rate (¥/$) 116.830 4.88%
One-year forward rate (¥/$) 112.450 5.16%
Investment rates, % per annum United States Japan

1 month 4.8750% 0.09375%
3 months 4.9375% 0.09375%
12 months 5.1875% 0.31250%
Purchased options Strike (yen/$) Premium

3-month call option on yen 118.000 1.0%
3-month put option on yen 118.000 3.0%
a. Alternative Hedges Values Certainty
1. Remain uncovered.
Possible spot rate in 90 days (yen/$) 118.255
Cash settlement in 90 days (US$) $169,126.04 Uncertain.
2. Forward market hedge.

Forward rate (won/$) 116.830
Cash settlement in 90 days (US$) $171,188.91 Certain.
3. Money market hedge.

Discount factor for 90 days 1.00523 1 + ((.0009375 + .02) x 90/360)
Yen proceeds up front 19,895,858
Current spot rate (won/$) 118.255
US dollars received now $168,245.38
Carry forward at Translucent's WACC 1.0400 1 + (.16 x 90/360)
Proceeds in 90 days $174,975.20 Certain.
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
If option exercised, dollar proceeds $169,491.53

Less Pm carried forward 90 days (5,276.732) 1.04 carry-forward rate
Net proceeds in 90 days $164,214.79 Minimum.
The put option does not GUARANTEE the company of settling for the booked amount.
The money market and forward hedges do; the money market yielding the higher proceeds.
b) Breakeven rate between the money market and the forward hedge is determined by the reinvestment rate:
Money market, US$ up-front $168,245.38
Forward contract, US$, end of 90 days $171,188.91
(1 + x) 101.750% $168,245.38 (1+x) = $171,188.91
x 1.74954% For 90 days
Breakeven rate, % per annum $0.06998
Problem 11.10 Farah Jeans
Farah Jeans of San Antonio, Texas, is completing a new assembly plant near Guatemala City. A final construction payment of
Q8,400,000 is due in six months. (“Q” is the symbol for Guatemalan quetzals.) Farah uses 20% per annum as its weighted
average cost of capital. Today’s foreign exchange and interest rate quotations are:
Construction payment due in six-months (A/P, quetzals) 8,400,000 $ 1,200,000.00 This is what we expect to pay in USD
Present spot rate (quetzals/$) 7.0000
Six-month forward rate (quetzals/$) 7.1000
Guatemalan six-month interest rate (per annum) 14.000%
U.S. dollar six-month interest rate (per annum) 6.000%
Farah's weighted average cost of capital (WACC) 20.000%
Farah's treasury manager, concerned about the Guatemalan economy, wonders if Farah should be hedging its foreign exchange
risk. The manager’s own forecast is as follows:
Expected spot rate in six-months (quetzals/$):

Highest expected rate 8.0000
Expected rate 7.3000
Lowest expected rate 6.4000
What realistic alternatives are available to Farah for making payment? Which method would you select and why?
a) What realistic alternatives are available to Farah? Cost Certainty
1. Wait six months and make payment at spot rate
Highest expected rate $ 1,050,000.00 Risky
Expected rate $ 1,150,684.93 Risky
Lowest expected rate $ 1,312,500.00 Risky
2. Purchase quetzals forward six-months $ 1,183,098.59 Certain

(A/P divided by the forward rate)
3. Transfer dollars to quetzals today, invest for six-months

quetzals needed today (A/P discounted 180 days) 7,850,467.29 ($7,850,467.29) This is just the PV
Cost in dollars today (quetzals to $ at spot rate) $ 1,121,495.33
factor to carry dollars forward 180 days (1 + (WACC/2)) 1.10
Cost in dollars in six-months ($ carried forward 180 days ) $ 1,233,644.86 Certain ($1,233,644.86) This is a FV
you have to borrow dollars
The second choice, the forward contract, results in the lowest cost alternative among certain alternatives.
Problem 11.11 PanAmerican Travel
PanAmerican Travel, a Honolulu, Hawaii – based 100% privately owned travel company has signed an agreement to acquire a
50% ownership share of Taipei Travel, a Taiwan – based privately owned travel agency specializing in servicing inbound
customers from the United States and Canada. The acquisition price is 7 million Taiwan dollars (T$ 7,000,000) payable in
cash in 3 months.
Susan Takaga, PanAmerican’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
amount will need to be borrowed personally by Susan Takaga. Taiwanese interest-bearing deposits by non-residents are
regulated by the government, and are currently set at 1.5% per year. She has a credit line with Bank of Hawaii for $200,000
with a current borrowing interest rate of 8% per year. She does not believe that she can calculate a credible weighted average
cost of capital since she has no stock outstanding and her competitors are all also privately-owned without disclosure of their
financial results. Since the acquisition would use up all her available credit, she wonders if she should hedge this transaction
exposure.
Assumptions Values
Acquisition price & 3-month A/P, NewTaiwan dollars (T$) 7,000,000
Spot rate (T$/$) 33.40
3-month forward rate (T$/$) 32.40
3-month Taiwan dollar deposit rate 1.500%
3-month dollar borrowing rate 8.000%
3-month call option on T$ not available
Susan Takaga's credit line with Bank of Hawaii $ 200,000
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
If spot rate is the same as 3-month forward rate $ 216,049.38 Risky
Although this would do nothing to cover the currency risk,

there would be no required payment or borrowing for 3 -months.
2. Buy T$ forward 3-months
Assured cost of T$ at 3-month forward rate $ 216,049.38 Certain
The purchase of a forward contract would not require any cash

up-front, but the Bank of Hawaii would reduce her available credit
line by the amount of the forward. This is a non-cash expense.
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
Spot rate, T$/$ 33.40
US$ needed now for exchange $ 208,797.85
US$ carry-forward rate (3-month dollar borrowing rate) 8.000% Certain

Carry-forward factor of US$ for 3-month period 1.0200
Total cost in US$ of settling A/P in 3-months with $ 212,973.80
Money Market Hedge
The currency risk is eliminated, but since Susan Takaga would have to exchange the money up-front, it would require her to
borrow the money, increasing her debt outstanding for the entire 3 months.
Discussion.
This is a difficult decision. The forward contract appears to be the preferable choice, protecting her against an appreciating T$,
and creating a certain cash purchase payment. The problem, however, will be whether the Bank of Hawaii will allow her to
purchase a forward for the full $216,049.38, which is slightly above her credit line currently in-place. If her relatonship is
good with the bank, they most likely would increase her line sufficiently to allow the forward contract.
Problem 11.12 Chronos Time Pieces
Chronos Time Pieces of Boston exports wristwatches 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 $1.16/€.
Assumptions Values
Account recievable in 90 days (€) € 1,560,000
Initial spot exchange rate ($/€) $1.2224
Forward rate, 90 days ($/€) $1.2270
Expected spot rate in 90 to 120 days ($/€): 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
hedged proportion 70% 120%
Minimum hedge in euros (exposure x min prop) € 1,092,000 € 1,872,000
at the forward rate ($/€) $1.2270 $1.2270
locking in ($) $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)
Value of covered proportion (from above) $1,339,884 $2,296,944
Total net proceeds, covered + uncovered $1,882,764 $1,935,024
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
Total net proceeds, covered + uncovered $1,929,564 $1,903,824
Benchmark: Full (100%) forward cover $1,914,120 $1,914,120
This is not a conservative hedging policy. Any time a firm may choose to leave any proportion uncovered, or purchase cover for more
than the exposure (therefore creating a net short position) the firm could experience nearly unlimited losses or gains.
Problem 11.13 Micca Metals, Inc.
Micca Metals, Inc. is a specialty materials and metals company located in Detroit, Michigan. The company specializes in
specific precious metals and materials which are used in a variety of pigment applications in many other industries including
cosmetics, appliances, and a variety of high tinsel metal fabricating equipment. Micca just purchased a shipment of phosphates
from Morocco for 6,000,000, dirhams, payable in six months. Micca’s cost of capital is 8.600%.
Six-month call options on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar are available from Bank Al-
Maghrub at a premium of 2%. Six-month put options on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar are
available at a premium of 3%. Compare and contrast alternative ways that Micca might hedge its foreign exchange transaction
exposure. What is your recommendation?
Assumptions Values
Shipment of phosphates from Morocco, Moroccan dirhams 6,000,000
Micca's cost of capital (WACC) 8.600%
Spot exchange rate, dirhams/$ 10.00
Six-month forward rate, dirhams/$ 10.40
Options on Moroccan dirhams: Call Option Put Option

Strike price, dirhams/$ 10.00 10.00
Option premium (percent) 2.000% 3.000%
United States Morocco

Six-month interest rate for borrowing (per annum) 6.000% 8.000%
Six-month interest rate for investing (per annum) 5.000% 7.000%
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.

Possible spot rate in six months -- forward rate (dirhams/$) 10.40
Cost of settlement in six months (US$) $ 576,923.08 Uncertain.
2. Forward market hedge. Buy dirhams forward six months.

Six month forward rate, dirhams/$ 10.40
Cost of settlement in six months (US$) $ 576,923.08 Certain.
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
Dirhams needed now for investing (payable/discount factor) 5,797,101.45
Current spot rate (dirhams/$) 10.00
US dollars needed now $ 579,710.14
Carry forward rate for six months (WACC) 1.043
US dollar cost, in six months, of settlement $ 604,637.68 Certain.
4. Call option hedge. (Need to buy dirhams = call on dirhams)

Option principal 6,000,000.00
Current spot rate, dirhams/$ 10.00
Premium cost of option 2.000%
Option premium (principal/spot rate x % pm) $ 12,000.00
If option exercised, dollar cost at strike price of 10.00 dirhams/$ $ 600,000.00

Plus premium carried forward six months (pm x 1.07, WACC) 12,516.000
Total net cost of call option hedge if exercised $ 612,516.00 Maximum.
The lowest cost certain alternative is the forward. If Micca were to expect the dirham to depreciate significantly over the next six
months, it may choose the call option.
Problem 11.14 Pixel's Financial Metrics
Leo Srivastava is the director of finance for Pixel Manufacturing, a U.S.-based manufacturer of hand-held computer systems for inventory
management. Pixel’s system combines a low-cost active barcode used on inventory (the barcode tags emit an extremely low grade radio
frequency) with custom-designed hardware and software which tracks the low grade emissions for inventory control. Pixel has completed the
sale of a barcode system to a British firm, Grand Metropolitan (UK), for a total payment of £1,000,000. The following exchange rates were
available to Pixel on the following dates corresponding to the events of this specific export sale. Assume each month is 30 days.
Spot Rate Forward Rate Days Forward

Date Event ($/£) ($/£) of Forward Rate
February 1 Price quotation by Metrica 1.7850 1.7771 210
March 1 Contract signed for sale 1.7465 1.7381 180
Contract amount, pounds £1,000,000
June 1 Product shipped to Grand Met 1.7689 1.7602 90
August 1 Product received by Grand Met 1.7840 1.7811 30
September 1 Grand Met makes payment 1.7290 --------- ---------
Analysis
a. The sale is booked at the exchange rate existing on June 1, when the product is shipped to Grand Met, 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).
Value as settled 1 million pounds @ $1.7290/pound $1,729,000

Value as booked 1 million pounds @ $1.7689/pound $1,768,900
FX gain (loss) ($39,900)
b. The value of the foreign exchange gain (loss) will depend upon when Leo 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
A more aggressive alternative is for Leo to purchase the forward contract on the date that the contract was signed, March 1, locking-in Pixel's
US dollar settlement amount a full 90 days earlier in the transaction exposure's life span.
Forward contract purchased on March 1

Value of forward settlement 1 million pounds @ $1.7381/pound $1,738,100
Note that in this case if Leo had covered forward on March 1st rather than June 1st, the amount of the foreign exchange loss would have been
even greater, although "fully hedged." The difference is of course the result of the forward rate changing with spot rates and interest
differentials.
Problem 11.15 Maria Gonzalez and Trident (A)
Trident — the same U.S.-based company as discussed throughout 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 Trident 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 Trident’s best interest?
Assumptions Value Value (B)

90-day A/R in pounds £3,000,000.00
Spot rate, US$ per pound ($/£) $1.7620
90-day forward rate, US$ per pound ($/£) $1.7550
3-month U.S. dollar investment rate 6.000%
3-month U.S. dollar borrowing rate 8.000%
3-month UK investment interest rate 8.000%
3-month UK borrowing interest rate 14.000%
Put options on the British pound: Strike rates, US$/pound ($/£) $1.75 $1.71
Put option premium 1.500% 1.000%
Trident's WACC 12.000%
Maria Gonzalez's expected spot rate in 90-days, US$ 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$.
Amount of A/R in 90-days, in pounds £3,000,000.00
Discount factor, pound borrowing rate, for 3-months 0.9662
Proceeds of borrowing, up-front, in pounds £2,898,550.72
Exchanged to US$ at current spot rate of $1.7620
US$ received against A/R, up-front $5,107,246.38
US$ need to be carried forward for comparison:
Carry-forward rate, WACC for 90-days 1.0300
Money Market Hedge, US$, at end of 90-days $5,260,463.77
Strike Rate ($/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
Carry-forward factor, WACC, for 90-days 1.0300 1.0300
Total premium cost, in 90-days $81,668.70 $54,445.80
Proceeds from put option if exercised $5,250,000.00 $5,130,000.00

Less cost of premium, including time-value (81,668.70) (54,445.80)
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
Less cost of option (allowed to expire OTM) (81,668.70) (54,445.80)
Net proceeds from put option, unexercised $5,265,831.30 $5,265,154.20
Analysis: Maria Gonzalez would receive the most certain US$ from the forward contract, $5,265,000; the money market hedge is
less attractive as result of the higher borrowing costs in the UK now. The two put options yield unattractive amounts if they had to be
exercised. As shown, the $1.75 strike price put option would be superior to the forward if the ending spot rate was $1.7825 or higher;
the $1.71 strike price would be superior to the forward if the ending spot rate were $1.7732 or higher.
Problem 11.16 Maria Gonzalez and Trident (B)
One year later Maria Gonzalez is still on the job at Trident. Trident’s business is booming, and sales have now expanded to include exports to Germany
and Japan, besides continuing sales to the United Kingdom. All export sales are invoiced in the local currency of the buyer. After creating a pro forma
income statement for Trident, answer the questions listed below.
a. If Maria Gonzalez leaves all positions uncovered, and the final spot rates at settlement are exactly what the FX advisor had forecast, what are the
foreign exchange gains (losses) for the period, and what is the final net income and earnings per share (EPS) figures?
b. If Maria Gonzalez covers all positions with full forward cover, and the final spot rates at settlement are exactly what the FX advisor forecast, what are
the foreign exchange gains (losses) for the period, and the final net income and earnings per share (EPS) figures?
c. If Maria Gonzalez uses a common industry practice of covering all positions 100% with forward cover if the forward rate earns her the points, while
only covering half the positions in which she is paying the forward points, what are the foreign exchange gains (losses) for the period and the final net
income and earnings per share (EPS) figures, assuming the following final settlement spot rates: $1.0480/€, $1.6000/£, ¥122.50/$?
Exchange Rate Assumptions Assumption Assumption Assumption Part c) Positions

Spot exchange rates at booking:
US dollars per euro ($/€) 1.0560 1.0560 1.0560
US dollars per pound ($/£) 1.5900 1.5900 1.5900
Japanese yen per dollar (¥/$) 122.43 122.43 122.43
90-day forward rates:
US dollars per euro ($/€) 1.0250 1.0250 1.0250 Paying points
US dollars per pound ($/£) 1.5875 1.5875 1.5875 Paying points
Japanese yen per dollar (¥/$) 120.85 120.85 120.85 Receiving points
Spot rate forecasts:
US dollars per euro ($/€) 1.0660 1.0660 1.0660
US dollars per pound ($/£) 1.5600 1.5600 1.5600
Japanese yen per dollar (¥/$) 126.00 126.00 126.00
Settlement spot rates:
US dollars per euro ($/€) ---------- ---------- 1.0480
US dollars per pound ($/£) ---------- ---------- 1.6000
Japanese yen per dollar (¥/$) ---------- ---------- 122.50
Export sales in currency of invoice:
Sales in European euros (€) € 2,340,000 € 2,340,000 € 2,340,000 50% Fwd Cover
Sales in British pounds (£) £1,780,000 £1,780,000 £1,780,000 50% Fwd Cover
Sales in Japanese yen (¥) 125,000,000 125,000,000 125,000,000 100% Fwd Cover
a) b) c)
FX gains (losses) by sale: Settled at Forecast Settled at Forward Forwards on Points
Sales in European euros $23,400 ($72,540) ($45,630)
Sales in British pounds ($53,400) ($4,450) $6,675
Sales in Japanese yen ($28,928) $13,349 $13,349
($58,928) ($63,641) ($25,606)
Uncovered 100% Forward Forward Cover

Income Statement (US$) Settled at Forecast Cover Based on Points
Sales $13,622,232 $13,622,232 $13,622,232
Domestic sales 7,300,000 7,300,000 7,300,000
Export sales 6,322,232 6,322,232 6,322,232
Less cost of goods sold 65% (8,854,451) (8,854,451) (8,854,451)
Gross profit $4,767,781 $4,767,781 $4,767,781
Less G&A expenses 9% (1,226,001) (1,226,001) (1,226,001)
Less depreciation (248,750) (248,750) (248,750)
Foreign exchange gains (losses) (58,928) (63,641) (25,606)
EBIT $3,234,102 $3,229,389 $3,267,424
Less US corporate taxes 40% (1,293,641) (1,291,755) (1,306,969)
Net income $1,940,461 $1,937,633 $1,960,454
Shares outstanding 1,000,000 1,000,000 1,000,000

Earnings per share (EPS) $ 1.940 $ 1.938 $ 1.960
Trident's EPS is highest in part c), where it determined its forward cover by whether it would receive or pay the forward points. In part c), for both the
euro and the pound, Trident is paying the points, and would therefore decide to cover 50% of the exposure with forwards (the yen is receiving the points,
and is 100% covered with forwards). The foreign exchange loss for the pound is smaller in part c) because the pound moved in the company's favor.
Although the euro moves against the firm, the loss is not as large as what would occur under the forward contract.
Problem 11.17 Solar Turbines
On March 1st, Solar Turbines, a wholly owned subsidiary of Caterpillar (US), sold a 12 megawatt compression turbine to Vollendam Dike
Company of the Netherlands for €4,000,000, payable €2,000,000 on June 1 and €2,000,000 on September 1. Redwall derived its price quote
of €4,000,000 on February 1 by dividing its normal U.S. dollar sales price of $4.320,000 by the then current spot rate of $1.0800/€.
By the time the order was received and booked on March 1, the euro had strengthened to $1.1000/€, so the sale was in fact worth
€4,000,000 x $1.1000/€ = $4,400,000. Solar had already gained an extra $80,000 from favorable exchange rate movements. Nevertheless
Solar's director of finance now wondered if the firm should hedge against a reversal of the recent trend of the euro. Four approaches were
possible:
1. Hedge in the forward market. The 3-month forward exchange quote was $1.1060/€ and the 6-month forward quote was $1.1130/€.
2. Hedge in the money market. Solar could borrow euros from the Frankfurt branch of its U.S. bank at 8.00% per annum.
3. Hedge with foreign currency options. June put options were available at strike price of $1.1000/€ for a premium of 2.0% per contract, and
September put options were available at $1.1000/€ for a premium of 1.2%. June call options at $1.1000/€ could be purchased for a premium
of 3.0%, and September call options at $1.1000/€ were available at a 2.6% premium.
4. Do nothing. Solar could wait until the sales proceeds were received in June and September, hope the recent strengthening of the euro
would continue, and sell the euros received for dollars in the spot market.
Assumptions Values Today is March 1

90-day Forward rate, $/€ $1.1060 Exchange Rate
180-day Forward rate, $/€ $1.1130 Date ($/€)
US Treasury bill rate 3.600% February 1 $1.0800
Solar's borrowing rate, euros, per annum 8.000% March 1 $1.1000
Solar's cost of equity 12.000%
Options on euros Strike ($/euro) Call Option Put Option

June maturity options $1.1000 3.0% 2.0%
September maturity options $1.1000 2.6% 1.2%
Valuation of Alternative Hedges June Receivable Sept Receivable

Amount of receivable, in euros € 2,000,000 € 2,000,000
a. Hedge in the forward market

Respective forward rates ($/€) $1.1060 $1.1130
US dollar proceeds as hedged ($) $2,212,000 $2,226,000
Carry forward to Sept 1 at WACC 1.03 -----
Total US$ proceeds on Sept 1st $2,278,360 $2,226,000
Total of both payments $4,504,360
b. Hedge in the money market

Discount factor for euro funds, period 1.02 1.04
Current proceeds from discounting, euros € 1,960,784 € 1,923,077
Current spot rate ($/€) $1.1000 $1.1000
Current US dollar proceeds $2,156,863 $2,115,385
Carry forward rate for the period 1.06 1.06
US dollar proceeds on future date $2,286,275 $2,242,308
Total of both payments $4,528,582
c. Hedge with options

Buy put options for maturities (% x spot value) ($44,000) ($26,400)
Carry forward for the period 1.06 1.06
Premium cost carried forward to Sept 1 ($46,640) ($27,984)
Gross put option value if exercised $2,200,000 $2,200,000

Carried forward 3 months to Sept 1 1.03 ----
Gross proceeds, Sept 1 $2,266,000 $2,200,000
Total net proceeds, after premium deduction, Sept 1 $4,391,376
d. Do nothing (remain uncovered)

Ending spot exchange rate ($/€) ??? ???
The money market hedge provides the highest certain outcome. If Solar Turbines believes the euro will strengthen versus the dollar over the
coming months, and it is willing to take the currency risk, the put option hedges could be considered.
Problem 11.18 Tek -- Italian Account Receivable
Tek wishes to hedge a €4,000,000 account receivable arising from a sale to Olivetti (Italy). Payment is due in 3 months. Tek’s
Italian unit does not have ready access to local currency borrowing, eliminating the money market hedge alternative. Citibank
has offered Tek the following quotes:
Assumptions Values
Account receivable due in 3 months, in euros (€) € 4,000,000.00
Spot rate ($/€) 1.2000
3-month forward rate ($/€) 1.2180
3-month euro interest rate 4.200%
3-month put option on euros:
Strike rate ($/€) 1.2000
Premium, percent per year 3.400%
Tek's weighted average cost of capital 9.800%
a) b)
What are the costs and risk of each alternative? Value Certainty?
1. Do nothing and exchange euros for dollars at end of 3 months

Amount of euro receivable € 4,000,000.00
If spot rate in 3 months is the same as the forward rate 1.2180 Very uncertain;
US dollar proceeds of receivable would be $4,872,000.00 Risky

If spot rate in 3 months is the same as the current spot rate 1.2000 Very uncertain;
US dollar proceeds of receivable would be $4,800,000.00 Risky
2. Sell euro receivable forward at the 3-month forward rate

forward rate 1.2180 Certain;
US dollar proceeds of receivable would be $4,872,000.00 Locked-in
3. Buy a put option on euros

Current spot rate ($/euro) 1.2000
Premium on put option, % 3.400%
Cost of put option (amount x spot rate x percent premium) $163,200.00
If the spot rate at end of 3-months is less than strike rate Minimum is
the option is exercised yielding gross dollars of $4,800,000.00 guaranteed;
Less cost of option (premium) plus US$ interest on premium (167,198.40) could be
Net proceeds of A/R if option is exercised (this is Minimum) $4,632,801.60 greater.
Summary of Alternatives Value Certainty?

Do Nothing $4,800,000.00 Risky
Sell A/R forward $4,872,000.00 Certain
Buy Put Option $4,632,801.60 Minimum
c) If Tek wishes to play it safe, it should lock in the forward rate.
d) If Tek wishes to take a reasonable risk (definining 'reasonable' is another issue), and has a directional view that the dollar is
going to depreciate versus the euro over the 3-month period, past $1.20/€, then Tek might consider purchasing the put option on
euros.
Problem 11.19 Tek -- Japanese Account Payable
Tek has imported components from its joint venture in Japan, Sony-Tek, with payment of ¥8,000,000 due in 6 months. Citibank has
offered Tek the following quotes
Assumptions Values
Account payable to Japan Sony-Tek, in Japanese yen (¥) ¥8,000,000.00
Spot rate (¥/$) ¥108.20
6-month forward rate (¥/$) ¥106.20
6-month yen deposit rate 1.250%
6-month dollar interest rate 4.000%
6-month call option on yen:
Strike rate (¥/$) ¥108.00
Premium, percent per year 2.500%
What are the costs and risk of each alternative? a) Value b) Certainty
1. Do nothing and exchange dollars for yen at end of 6 months

Amount of yen payable ¥8,000,000.00
If spot rate in 3 months is the same as the forward rate ¥106.20 Very uncertain;
US dollar cost of settling payable would be $75,329.57 Risky

If spot rate in 3 months is the same as the current spot rate ¥108.20 Very uncertain;
US dollar cost of settling payable would be $73,937.15 Risky
2. Buy yen forward 6-months to lock in cost of settling payable

forward rate ¥106.20 Certain;
US dollar cost of settling payable would be $75,329.57 Locked-in
3. Money market hedge -- invest funds in yen deposit now
Principal needed at the end of 6-months, yen ¥8,000,000.00

Discount factor, 6-months @ yen deposit rate 0.9938 1/(1 + (.0125 x 180/360))
Yen deposit needed, now ¥7,950,310.56
Current spot rate (¥/$) 108.20
US dollars needed now, for exchange into yen $73,477.92
Carry-forward rate, 6 months @ Tek's WACC 1.05 1 + (.0980 x 180/360)
US cost of money market hedge at end of 6-months $77,078.33
4. Buy a call option on Japanese yen

Current spot rate (¥/$) ¥108.20
Premium on call option, % 2.500%
Cost of call option $1,848.43
If the spot rate at end of 3-months is greater than strike rate Maximum cost
the option is exercised yielding gross dollars of $74,074.07 guaranteed;
Plus cost of option (premium) plus US$ interest on premium 1,939.00 could be
Total cost of exercising call option on yen $76,013.08 less.
Summary of Alternatives: Cost of settling A/P Value Certainty?

Do Nothing $73,937.15 Risky
Buy yen forward $75,329.57 Certain
Deposit yen now (money market hedge) $77,078.33 Certain
Buy call option on yen $76,013.08 Maximum
c) If Tek wishes to take a reasonable risk (definining 'reasonable' is another issue), and has a directional view that the yen may be
depreciating (falling) versus the dollar over the coming 6-month period, somewhere below the option strike rate of ¥108/$, then Tek might
consider purchasing the call option. If Tek is a bit more risk adverse, the forward rate is relatively attractive compared to the money market
hedge.
Problem 11.20 Tek -- British Telecom Bidding
Tek has made a £1,500,000 bid to supply and install a network monitoring system for British Telecom in Manchester, U.K. The bid is
good for 30 days at which time the winner of the bidding process will be announced. Other bidders are expected to be Agilent, Siemens,
and at least two British firms. If Tek wins the bid it will have 60 days to build and install the system.
During this 90-day period the £1,500,000 will be accounted for as backlog. Upon delivery and testing of the system British Telecom will
make full payment 30 days later. During this month Tek will account for the £1,500,000 as backlog. Barclay’s Bank (UK) has offered
Tek the following quotes:
Assumptions Values
Account receivable of bid, supply & install (British pounds, £) £1,500,000
Spot rate ($/£) 1.8418
1-month 4-month
Forward rate ($/£) 1.8368 1.8268
British pound investment rate 4.000% 4.125%
British pound borrowing rate 6.500% 6.500%
Put option on pound:
Strike rate ($/£) 1.85 1.85
Premium ($/£) $0.006 $0.012
Analysis and Evaluation a) Value b) Certainty
If Tek wins the bid, it will be long foreign currency, having a 1.5 million pound position which is first backlog, then becoming an A/R.
If and when Tek is awarded the bid, it would have 4 months (120 days) until cash settlement of the 1 million pound position.
1. Do Nothing -- Remaining Uncovered

Wait 120 days and exchange pounds for dollars spot
If the ending spot rate is the same as current spot rate $2,762,700.00 Risky
If the ending spot rate is the same as the 4-month forward rate $2,740,200.00 Risky
It could, however, be much lower.
2. Sell the pounds forward

Selling 1 million pounds forward at the 4-month forward rate $2,740,200.00 Certain Value
The primary problem with this is that if Tek does not win the bid, If Tek Wins Bid
it has a forward contract to sell pounds which it will not earn.
3. Money market hedge -- borrow against expected receipts

Expected receipts (£) £1,500,000
Discount factor for 4-months at pound borrowing rate 0.9788 1/(1+(0.065 x 120/360))
Proceeds from borrowing, now (£) £1,468,189
Current spot rate ($/£) 1.8418
Proceeds from borrowing, now ($) $2,704,110.93
Carry-forward rate, 4 months @ Tek's WACC 1.0327 1 + (.098 x 120/360)
Value in 4 months of money market hedge ($) $2,792,445.22
4. Buy a put option on pounds at strike price of 1.58

Option, if exercised (if ending spot rate less than $1.85) $2,775,000.00
Put option premium, up-front $18,000.00

and the 4-months opportunity cost of premium 588.00
Total premium expense $18,588.00
Minimum;
Minimum dollars received if put option purchased $2,756,412.00 Could be More
The money market hedge provides the largest dollar value at the end of 4 months, but it assumes certainty of bid's award. The advantage
of the option is if Tek does not win the bid, the option can easily be sold.
Problem 11.21 Tek -- Swedish Price List
Tek offers oscilloscopes and other off-the-shelf products through foreign-currency-denominated price lists. The prices are valid for 3
months only. One example is a Swedish price list expressed in Swedish kronor (SKr). In effect, customers are given a cost-free call
option on products with a fixed dollar/krona exchange rate. During a typical 3-month period, Tek could expect to sell SKr 5,000,000 –
SKr 10,000,000 worth of products based on the price list. Since the SKr/$ exchange rate is likely to change during any 3-month
period, Tek would like to hedge this transaction exposure (Tek’s Swedish business unit does believe the krona will be strengthening
versus the dollar in the coming months). Nordea Bank (Sweden) has offered Tek the following quotes:
Assumptions Values
Expected sale over 90-day period, Swedish krona (SKr) 5,000,000.00 Could be more
Spot rate (SKr/$) 7.4793
90-day forward rate (SKr/$) 7.4937
3-month dollar interest rate 4.000%
3-month krona deposit interest rate 4.780%
3-month krona borrowing interest rate 6.500%
3-month put option on krona:
Strike rate (SKr/$) 7.50
Premium 2.500%
Hedging Alternatives
This is an uncertain exposure. Although sales will most likely occur, it is not known what total quantity of
sales will occur, and therefore what Tek's actual long position in Swedish krona will be.
Value Certainty?
1. Do Nothing -- Remain Uncovered.
The ending spot rate at the time of settlement
could be nearly anything.
If the ending spot rate is the same as current spot rate (SKr/$) $668,511.76 Risky
If the ending spot rate is the same as forward (SKr/$) $667,227.14 Risky
2. Sell Swedish krona forward
Sold forward 3-months at forward rate (SKr/$) $667,227.14 Certain

However, remember that Tek does not know total sales.
3. Money market hedge

Tek would borrow now against expected proceeds of (SKr) 5,000,000.00
Discount rate of SKr interest rate for 90-days 0.98401
SKr proceeds from borrowing received up-front 4,920,049.20
Exchanged at current spot rate (SKr/$) 7.48
US dollars received now $657,822.15
Tek carry-forward rate for US$ for 90 days 1.025
Money market hedge proceeds in 90-days $673,938.79
4. Buy a 3-month put option on Swedish krona If exercised If not exercised

Proceeds will be option less premium if exercised (minimum) (random choice)
Exchange rate if exercised/not exercised (SKr/$) 7.50 7.24
Amount of Swedish krona 5,000,000.00 5,000,000.00
If exercised, it will yield a gross dollar amount of $666,666.67 $690,607.73
Put option premium $16,712.79 $16,712.79

Opportunity cost of premium 409.46 409.46
Total future value of premium $17,122.26 $17,122.26
Minimum net dollar proceeds at end of 90 days $649,544.41 $673,485.48

(exercised gross amount less future value of premium) Minimum
The money market hedge provides the highest certain US dollar receipts. (This is again a result of the significant increase in relative
value arising from carrying-forward the dollars at Tek's WACC.)
If Tek sincerely believes in its directional view, and is willing to take some currency risk, the SKr would have to fall to about SKr7.24
(shown above) in order for the put option to yield roughly the same amount of US dollars as the money market hedge.
Problem 11.22 Tek -- Swiss Dividend Payable
Tek’s European subsidiaries are formally owned by a holding company, Tek-Switzerland. Thus, the subsidiaries pay dividends to the
Swiss holding company, which in turn pays dividends to Tek-Beaverton. Tek has declared a dividend of 5 million Swiss francs
payable in 3 months from Switzerland to Tek-Beaverton. If Tek-Beaverton wishes to hedge this transaction exposure it could utilize
the following quotes from Swiss Bank Corporation:
What are the costs of each alternative for hedging the dividend payable? What are the risks of each alternative? Which alternative
should Tek choose? Explain your assumption about Tek’s motivation in choosing your suggested alternative.
Assumptions Values
Dividend declared, Swiss francs (SFr) SFr. 5,000,000
Spot rate (SFr/$) 1.2462
90-day forward rate (SFr/$) 1.2429
3-month US dollar interest rate 4.000%
3-month Swiss franc interest rate 3.750%
3-month put option on Swiss francs:
Strike rate (SFr/$) 1.25
Premium ($/SFr) $0.015
Tek's expected spot rate in 90 days (SFr/$) 1.22
Hedging Alternatives Value Certainty?
1. Do Nothing -- Remain Uncovered.
If the ending spot rate is the same as current spot rate (SFr/$) $4,012,197.08 Risky
If the ending spot rate is the same as forward (SKr/$) $4,022,849.79 Risky
Realistically, the ending spot rate could vary between SFr1 and SFr2 per $.
2. Sell Swiss francs forward
Sold forward 3-months at forward rate (SFr/$) $4,022,849.79 Certain

Borrow SFr now against future receipt
Principal SFr. 5,000,000
Borrow SFr at SFr interest rate for 90-days 0.9907
SFr proceeds received now via borrowing SFr. 4,953,560
Exchanged into US$ at spot rate of (SFr/$) 1.25
Dollars received now $3,974,932.09
Carry-forward rate for US$ at Tek's WACC for 90-days 1.0245
Money Market Hedged proceeds in 90 days $4,072,317.93
4. Buy a 3-month put option on Swiss francs If exercised If not exercised
Proceeds = option - premium, if exercised (minimum)

Effective exchange rate if exercised/not exercised, SFr/$ 1.25 1.22
Principal of payment, SFr SFr. 5,000,000 SFr. 5,000,000
If exercised, it will yield a gross dollar amount of $4,000,000.00 $4,098,360.66
Put option premium $75,000.00 $75,000.00

Opportunity cost of premium 1,837.50 1,837.50
Total future value of premium $76,837.50 $76,837.50
Minimum net dollar proceeds at end of 90 days $3,923,162.50 $4,021,523.16

(exercised gross amount less future value of premium) Minimum
Analysis. The Money market hedge yields the highest certain US dollar proceeds. If, however, Tek wishes to accept some degree of
currency risk, and believes in the direciton of a stronger SFr, it may choose the 3-month put option. Note that the official expectation
is SFr1.22/$. This is still not superior to the Money Market Hedge. (The ending spot rate would need to be SFr1.20/$ or stronger to
end up superior to the Money Market Hedge.)

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Problem 11.

Calculation of Foreign Exhange Loss on Repayment of Loan

Exchange rate at time of repayment, baht/dollar 25.00

Exchange rate at time of repayment, baht/dollar 42.00

1. Remain Uncovered, settling A/P in 180 days at spot rate

2. Buy Japanese yen forward 180 days

Settlement amount at forward rate (Rs) 3,541,666.67 2.4000 Certain

3. Money Market Hedge

Current spot rate (¥/Rs) 2.5257

4. Indian Currency Agent Hedge

Plus agent's fee (4.850%) 163,225.02

Total A/P, future value, A/P + fee (Rs) 3,538,482.87 Certain

1. Allow the discount and receive payment in Japanese yen in cash

Account recievable (yen) 12,500,000

Current spot rate 111.40

Account receivable (yen) 12,500,000

Discount factor for 30 days @ Seattle's WACC 0.9924

Assumptions Values At Spot

Settle A/R in 90 days at current spot rate.

If spot rate in 90 days is same as current $174,603.17 Risky

If spot rate in 90 days is Rp9,400/$ $175,531.91 Risky

If spot rate in 90 days is Rp9,950/$ $165,829.15 Risky

2. Sell Indonesian rupiah forward.

A/R sold forward 90 days $165,829.15 Certain

"Cost of cover" is the forward discount on Rp -20.1%

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 11.6 Caterpillar

Options on Korean won: Call Option Put Option

United States Korea

Risk Management Alternatives Values Certainty

1. Remain uncovered, making the won payment in 6 months

Account payable (won) 6,030,000,000

2. Forward market hedge. Buy won forward six months

Account payable (won) 6,030,000,000

Account payable (won) 6,030,000,000

4. Call option hedge. (Need to buy won = call on won)

If option exercised/not exercised, dollar cost of won $ 5,025,000.00 $ 4,613,618.97

1. Remain Uncovered, settling A/R in 90 days at market 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 Barclays forward rate $42,585,000.00 Risky

If spot rate in 90 days is expected spot rate $42,600,000.00 Risky

2. Sell euros forward 90 days

Settlement amount at Credit Suisse forward rate $42,516,000.00 Certain

Settlement amount at Barclays forward rate $42,585,000.00 Certain

3. Money Market Hedge

Current spot rate, $/euro $1.4158

Future value of money market hedge $42,956,420.74 Certain

Analysis & Exposure Management

DKr Forward Cover

Forward rates and premiums Forward Rate Premium

Investment rates, % per annum United States Japan

Purchased options Strike (yen/$) Premium

a. Alternative Hedges Values Certainty

2. Forward market hedge.

3. Money market hedge.

4. Put option hedge. (Need to sell yen = put on yen)

If option exercised, dollar proceeds $169,491.53

Expected spot rate in six-months (quetzals/$):

a) What realistic alternatives are available to Farah? Cost Certainty

1. Wait six months and make payment at spot rate

Highest expected rate $ 1,050,000.00 Risky