Week 6 Homework
Strayer University
2013
19. Comparing Transaction and Economic Exposure.
Erie Co. has most of its
business in the U.S.,except that it exports to Belgium. Its exports were invoiced
inEuros (Belgiumâs
currency) last year. It has no other economic exposure to exchange rate risk.
Its main
competition when selling
to Belgiumâs customers is a company in Belgium that sells similar products,
denominated inEuros. Starting today,
Erie Co. plans to adjust its pricing strategy to invoice its exports in
U.S. dollars instead ofEuros. Based on the
new strategy, will Erie Co. be subject to economic exposure to
exchange rate risk in the
future? Briefly explain.
25. Potential
Effects if the United
Kingdom Adopted the Euro.
The U.K. still has its own currency, the pound. The
poundâs interest rate has historically been higher than
theEuros interest rate. The U.K. has considered adopting the
euro as its currency. There have been many
arguments about whether it should do so.
Use your knowledge and intuition to discuss
the likely effects if the United Kingdom adopts the euro. For
each of the 10 statements below, insert
eitherincrease or decrease and complete the
statement by
adding a clear short explanation (perhaps
one to three sentences) of why the U.K.âs adoption of the euro
would have that effect.
To help you narrow your focus, follow these
guidelines. Assume that the pound is more volatile than the
euro. Do not base your answer on whether
the pound would have been stronger than the euro in the
future. Also, do not base your answer on an
unusual change in economic growth in the U.K. or in the euro
zone if the euro is adopted.
32. Comparison
of Techniques for Hedging Receivables.
A. Assume that Carbondale
Co. expects to receive S$500,000 in one year. The existing spot rate of
the Singapore dollar is
$.60. The one?year forward rate of the Singapore dollar is $.62.
Carbondale created a
probability distribution for the future spot rate in one year as follows:
Future Spot Rate Probability
$.61 20%
.63 50
.67 30
Assume that one?year put options on Singapore dollars are available,
with an exercise price of $.63 and a
premium of $.04 per unit. One?year call options on Singapore dollars are available
with an exercise price
of $.60 and a premium of $.03 per unit. Assume
the following money market rates:
U.S. Singapore
Deposit rate 8% 5%
Borrowing rate 9 6
Given this information,
determine whether a forward hedge, money market hedge, or a currency options
hedge would be most
appropriate. Then compare the most appropriate hedge to an unhedged
strategy,
and decide whether
Carbondale should hedge its receivables position.
b. Assume
that Baton Rouge, Inc. expects to need S$1 million in one year. Using any
relevant
information in part (a) of this question, determine
whether a forward hedge, a money market hedge, or a
currency options hedge would be most
appropriate. Then, compare the most appropriate hedge to an
unhedged strategy, and decide whether Baton Rouge
should hedge its payables position.
34. Exposure to September 11.
If you were a U.S. importer of products from
Europe, explain whether the September 11, 2001
terrorist attack on the U.S. would have caused
you to hedge your payables (denominated in
Euros) due a few months later. Keep in mind that the attack was followed by
a reduction in U.S.
interest rates.
40. Hedging Decision.
Chicago Company expects to receive 5
millionEuros in one year from exports.
It can use any one
of the following strategies to deal with the exchange rate risk. Estimate the
dollar cash
flows received as a
result of using the following strategies:
a. unhedged
strategy
b. money
market hedge
c. option
hedge
The spot rate of the euro as of today is
$1.10. Interest rate parity exists. Chicago
uses the forward rate
as a
predictor of the future spot rate. The annual interest rate in the U.S. is 8%
versus an annual
interest rate of 5% in theeuro zone. Put options onEuros are available with an exercise price of
$1.11, an expiration date of one year from
today, and a premium of $.06 per unit. Estimate the dollar
cash flows it will receive as a result of
using each strategy. Which hedge is optimal?
11. Managing
Economic Exposure.St. Paul Co. does
business in the United States
and New Zealand.
In attempting to
assess its economic exposure, it compiled the following information.
a. St. Paulâs U.S. sales are somewhat affected by the value of
the New Zealand dollar
(NZ$),
because it faces competition from New
Zealand exporters. It forecasts the U.S. sales based on the
following three exchange rate scenarios:
Revenue from U.S. Business
Exchange Rate of NZ$ (in millions)
NZ$ = $.48 $100
NZ$ = .50 105
NZ$ = .54 110
b. Its New Zealand dollar revenues on sales to New Zealand invoiced in New Zealand dollars are
expected to be
NZ$600 million.
c. Its
anticipated cost of materials is estimated at $200 million from the purchase of
U.S. materials
and NZ$100 million
from the purchase of New Zealand materials.
d. Fixed operating expenses are estimated at $30
million.
e.
Variable operating
expenses are estimated at 20 percent of total sales (after including New
Zealand sales, translated to a dollar
amount).
f. Interest
expense is estimated at $20 million on existing U.S.
loans, and the company has no
existing New Zealand loans.
Forecast net cash flows for St. Paul Co.
under each of the three exchange rate scenarios. Explain how
St. Paul’s projected
net cash flows are affected by possible exchange rate movements. Explain
how it can
restrucÂture its
operations to reduce the sensitivity of its net cash flows to exchange rate
movements
without reducing its
volume of business in New Zealand.
12. Assessing Economic
Exposure.
Alaska Inc. plans to
create and finance a subsidiary in Mexico that produces computer components at
a low cost and
exports them to other countries. It has no other international business. The
subsidiary
will produce
computers and export them to Caribbean islands and will invoice the products in
U.S.
dollars. The values
of the currencies in the islands are expected to remain very stable against the
dollar. The
subsidiary will pay wages, rent, and other operating costs in Mexican
pesos. The
subsidiary will
remit earnings monthly to the parent.
a.
Would Alaskaâs cash flows be
favorably or unfavorably affected if the Mexican peso depreciates
over time?
b.
Assume that Alaska
considers partial financing of this subsidiary with peso loans from Mexican
banks instead of
providing all the financing with its own funds. Would this alternative form of
financing increase,
decrease, or have no effect on the degree to which Alaska is exposed to
exchange rate
movements of the peso?
13. Hedging
Continual Exposure.
Consider this common real-world dilemma
by many firms that rely on exporting.
Clearlake Inc. produces
its products in its factory in Texas, and
exports most of the products to Mexico each month. The exports
are denominated in pesos. Clearlake Inc.
recognizes that hedging on a monthly basis does not really
protect against long-term movements in
exchange rates. It also recognizes that it could eliminate its
transaction exposure by denominating the
exports in pesos, but that it still would have economic exposure
(because Mexican consumers would reduce
demand if the peso weakened). Clearlake Inc. does not know
how many pesos it will receive in the
future, so it would have difficulty even if a long-term hedging
method were available. How can Clearlake
realistically deal with this dilemma and reduce its exposure
over the long-term? [There is no perfect
solution, but in the real world, there rarely are perfect solutions.]
