Homework problems – Foreign Exchange transaction risk Problems Please work and post your answers to problems A. Krystal. Krystal is a U.S.-based company that manufactures, sells, and installs water...

Homework problems – Foreign Exchange transaction risk Problems

Please work and post your answers to problems

A. Krystal. Krystal is a U.S.-based company that manufactures, sells, and installs water purification equipment. On April 11, 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.

Note that the interest rate differentials vary slightly from the forward discounts on the yen because of time differences for the quotes. The spot ¥118.255/$, for example, is a mid-point range. On April 11, the spot yen traded in London from ¥118.30/$ to ¥117.550/$. Aquatech’s Japanese competitors are currently borrowing yen from Japanese banks at a spread of two percentage points above the Japanese money rate. Krystal’s weighted average cost of capital is 16%, and the company wishes to protect the dollar value of this receivable. 3-month options are available from Kyushu Bank: call option on ¥20,000,000 at exercise price of ¥118.00/$: a 1% premium; or a put option on ¥20,000,000, at exercise price of ¥118.00/$: a 3% premium.

What are the costs and benefits of alternative hedges? Which would you recommend, and why? What is the break-even reinvestment rate when comparing forward and money market alternatives?

B. Caribou River. Caribou River, 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 cover formula:

Caribou expects to receive multiple payments in Danish kroner over the next year. DKr3,000,000 is due in 90 days; DKr2,000,000 is due in 180 days; and DKr1,000,000 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 for each period?

C. Pupule Travel. Pupule Travel, a Honolulu, Hawaii-based 100% privately owned travel company, has signed an agreement to acquire a 50% ownership share of Taichung 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 three months. Thomas Carson, Pupule Travel’s owner, believes the Taiwan dollar will either remain stable or decline slightly over the next three months. At the present spot rate of T$33.40/$, the amount of cash required is only $200,000, but even this relatively modest amount will need to be borrowed personally by Thomas Carson. Taiwanese interest-bearing deposits by non-residents are regulated by the government, and are currently set at 1.5% per year. He has a credit line with Bank of Hawaii for $200,000 with a current borrowing interest rate of 8% per year. He does not believe that he can calculate a credible weighted average cost of capital since he has no stock outstanding and his competitors are all also privately held. Since the acquisition would use up all his available credit, he wonders if he should hedge this transaction exposure. He has the following quotes from the Bank of Hawaii:

Analyze the costs and risks of each alternative, and then make a recommendation as to which alternative Thomas Carson should choose. 10.10 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.

D. Burton Manufacturing.( extra Credit )

Jason Stedman is the director of finance for Burton Manufacturing, a U.S.-based manufacturer of handheld computer systems for inventory management. Burton’s system combines a low-cost active tag that is attached to inventory items (the tag emits an extremely low-grade radio frequency) with custom-designed hardware and software that tracks the low-grade emissions for inventory control. Burton has completed the sale of an inventory management system to a British firm, Pegg Metropolitan (UK), for a total payment of £1,000,000. The exchange rates shown at the bottom of this page were available to Burton on the dates shown, corresponding to the events of this specific export sale. Assume each month is 30 days.

a. What will be the amount of foreign exchange gain (loss) upon settlement?

b. If Jason hedges the exposure with a forward contract, what will be the net foreign exchange gain (loss) on settlement?

Please follow the following instructions in completing and posting your answers

The best way to solve the problems assigned each week is the following systematic and deliberate approach

I usually advise students to: (a) write a short narrative of what the problem is calling for and the formulas that you will need to get the answer (b) separate the data given (c) create a work station that you do intermediate calculations ( d) check to see if the answer that you have gotten matches what you were looking for and box your response

Following these steps will make life a lot easier and the work more enjoyable