International Economics and Finance Exchange Rate Risk Management

Universitas Islam Indonesia Case of Vogl Co. U.S.

Currency Total Inflow Total Outflow Net Cash flow

Canadian Dollar (C$) C$ 32,000,000 C$ 2,000,000 C$ 30,000,000
New Zealand Dollar (NZ$) NZ$ 5,000,000 NZ$ 1,000,000 NZ$ 4,000,000
Mexican Peso (MXP) MXP 11,000,000 MXP 10,000,000 MXP 1,000,000
Singapore dollar (S$) S$ 4,000,000 S$ 8,000,000 (-) S$ 4,000,000*

*= Loss

1. Net Cash Flow Exposure using Spot rate

Currency Spot rate Net Flow in U.S dollar ($)

Canadian Dollar (C$) $ .90 30,000,000 * .90 = 27,000,000
New Zealand Dollar (NZ$) .60 4,000,000 * .60 = 2,400,000
Mexican Peso (MXP) .18 1,000,000 * .18 = 180.000
Singapore dollar (S$) .65 (-) 4,000,000 * .65 = (-) 2,600,000
Total Net Flow in U.S. Dollar $ 26,080,000

2. Anticipating unpredictable future exchange rate

Currency Spot rate as a One – year Rate against U.S $ ∆ Rate

Future Spot Rate Forward Rate comparing Forward
rate with spot rate
Canadian Dollar (C$) $ .90 $ .93 Appreciate .03
New Zealand Dollar (NZ$) .60 .59 Depreciate .01
Mexican Peso (MXP) .18 .15 Depreciate .03
Singapore dollar (S$) .65 .64 Depreciate .01

Total net flow using future spot rate: $ 26,080,000

Net Flow using Forward rate (per currency)

Currency One – year Net Flow in U.S dollar ($)

Forward Rate
Canadian Dollar (C$) $ .93 30,000,000 * .93 = 27,900,000
New Zealand Dollar (NZ$) .59 4,000,000 * .59 = 2,360,000
Mexican Peso (MXP) .15 1,000,000 * .15 = 150.000
Singapore dollar (S$) .64 (-) 4,000,000 * .64 = (-) 2,560,000
Total Net Flow in U.S. Dollar $ 27.850.000

Base on calculation above, the company gain positive on net flow around $ 1,770,000 by hedging
through forward contract per currency. Although the majors currencies are depreciating against dollar,
the appreciation of Canadian Dollar (C$) make the balance are increase. It also the Canada Subsidiaries
has the biggest contribution for the Main Company. The depreciation on Singapore dollar also gives
good impact to the company balance. The loss in Singapore subsidiaries also has been cut-off around
International Economics and Finance Exchange Rate Risk Management
Universitas Islam Indonesia Case of Vogl Co. U.S.

$40,000. For the conclusion, if the net flow from subsidiaries is positive, it would be better if the
subsidiary rate is appreciated against U.S and for the net flow subsidiary which in Loss, its better if the
exchange rate is deprecated.

If in the future there are offsetting exchange rate, there would be affect to the company because the
forecasting is failed. It true from the calculation, we can see the critical affect happening in Canadian
Dollar (C$) and the Singapore Dollar (S$). Both of them are the main currencies that have biggest
contribution in the company balance. Canadian Dollar contributes C$30,000,000 in income and has the
highest rate among the other currency involve (exclude U.S. dollar). The Singapore dollar also being
crucial, because the transaction in Singapore Dollar are negative and the amount is the second highest
and have the second highest in exchange rate.

If the future rates are determine by that, we are trying to give another suggestion besides using forward
contract per currency. We try to make a forward contract in the Canadian Dollars to minimize the
exchange rate risk. so in our suggestion, vogl’s must turn in their net flow currency in Canadian dollar
(exclude Singapore Dollar, because the transaction there are negative) and put it on forward market to
get rate $0.93 Because the exchange rate is appreciate so in the future we can get much U.S dollar.
Calculation:
Total net cash flow1: $ 26,080,000 – (-) $ 2,600,000 = $ 28,680,000
Turn into Canadian Dollar (using spot rate, spot rate = 0.90); $28,680,000 * 1/ .90 = C$ 31,888,889
Total gain in U.S dollar if using forward market based on Canadian Dollar (forward rate= .93):
C$31,866,667 (.93) = $ 29,636,000

There still uncalculated in Singapore transaction,

Option 1. Spot rate for Singapore dollar to U.S. Dollar is 0.65.
Exchange several amount cash inflow to cover the loss in Singapore using spot rate $29,636,000 -
$2,600,000 = $27,036,000
So the total net flow for the Vogl’s in using that method is $ 27,036,000
Option 2. Get Singapore dollar by forward contract.
Vogl’s need S$ 4,000,000; we can get it made forward contract $2,560,000 (forward rate $0.64) and get
S$ 4,000,000 in the future. so the vogl’s gain $ 29,636,000 – $ 2,560,000 = $ 27,076,000

3. Net Cash flow in Canadian Dollar (C$) analysis

Net Cash Flow in Canadian Dollar (using spot rate) =

Net Cash Flow in U.S $ * (1/0.9) = C$ 28, 977, 777, 77

Net Cash Flow in Canadian Dollar (using Forward rate) = Net Cash Flow in U.S $ * (1/0.93) =

Net Cash Flow in U.S $ * (1/0.9) = C$ 29,946,236.56

1
without the transaction in Singapore subsidiary
International Economics and Finance Exchange Rate Risk Management
Universitas Islam Indonesia Case of Vogl Co. U.S.

Net Cash Flow Spot Rate Forward Rate

Net Cash Flow in U.S Dollar $ 26,080,000 $ 27.850.000
Net Cash Flow in Canadian Dollar C$ 28, 977, 777, 77 C$ 29,946,236.56

Hedging Canadian Dollar (exclude premium cost)

It would be true in expecting better rate of Canadian Dollar (the Canadian dollar appreciates against the
U.S dollar) for gaining additional U.S Dollar.

That Vogl Co. anticipates receiving C$ 28,977,777,- in a year. During this period, Vogl Co. is in a
uncovered position. If the dollar price of the Canadian dollar (the dollar appreciates against the
Canadian dollar), Vogl’s receipts will be worth less than C$ 28,977,777 ,- are converted to dollars.

To avoid this foreign exchange risk, Vogl can contract to sell its expected Canadian receipts in the
forward market at today’s forward rate. By locking into a set forward-exchange rate, Vogl is guaranteed
that value of its Canadian Dollar receipts will be maintained in term of the dollar, even if the value of
Canadian Dollar should not happen to fall. With the current forward rate, Vogl can gain C$ 29,946,236.-.
So it prefers to hedge in Canadian dollar and sell it in forward market.

4. Forecasted Cash Flow related to Hedging Activities

Assumption:

- The range of Net Cash Flow in Canadian Dollar is C$ 20,000,000 – C$ 40,000,000

- Hedging C$ 30,000,000, using forward contract gain $ 27,900,000
- one year - forward rate for Canadian dollar is $ 0.93

Based on those assumptions, we know that the lowest point is around C$ 20,000,000 and the highest
point is C$ 40,000,000. In assumption for hedging C$ 30,000,000, there C$ 10,000,000 differences in
both of case if the net cash flow either in lowest and highest level.

The risks come from the unpredictable net inflow and the exchange rate. Below the calculation about it
for every condition in term lowest and highest point;

Condition 1. If the net inflow is same with the amount that being hedge. (C$ 30,000,000) the company
would not face any risk from that decision.

Condition 2. If the net inflow is less than the hedging amount (C$ 20,000,000), automatically the
company faces the risk from it. Vogl’s must get C$ 10,000,000 to cover their contract.
International Economics and Finance Exchange Rate Risk Management
Universitas Islam Indonesia Case of Vogl Co. U.S.

- Option 1.
At the end of contract, vogl’s can cover it by making short loan from the bank or other financial
institution at certain rate to get C$ 10,000,000. In this strategy, Vogl’s must find the financial
institutions that offer the loan with the lowest rate or lower than the forward rate ( .93)
case:
1. If the future spot rate of Canadian is higher than Forward rate
2. If the future spot rate Canadian Dollar is lower than forward rate
- Option 2.
No ideas…. using call option?

Condition 3. If the amount of net inflow over the hedging (C$ 40,000,000), the company faces risk if the
future spot rate of Canadian dollars is depreciating against dollars instead the company can gain more if
the future spot rate of Canadian dollar is appreciating against U.S dollar.

If the vogl’s made a forward contract in amount of C$ 40,000,000; they would get $ 37,200,000.

If in the future, the spot rate is lower than the forward rate, the Vogl’s missing to maximize their profit
in term Exchange rate. For example the future spot rate is 0.90. The amount is not invested is C$
10.000.000. Vogl’s only gain $ 9,000,000 + $ 27,900,000 = $ 36,900,000.

But, if in the future the spot rate is higher than a forward rate, Vogl’s would gain more than the amount
expected if they invest their all money in forward market.

5. Long Term Investment in term of eliminating the exposure to Exchange Rate

Illustration:

Main Office Investment Canada Subsidiary

(In U.S.)

Canada

= products flow

= Fund Flow
International Economics and Finance Exchange Rate Risk Management
Universitas Islam Indonesia Case of Vogl Co. U.S.

Investment Activity overview

Based on investment activity that made by the Vogl’s, want to try to eliminate the in exchange rate
fluctuation. I think, it not fully eliminated the exchange rate exposure risk. Because the main corporate
still in U.S and use U.S. Dollar as their currency in their balance reports.

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