Case Studies Chapter 4+5 PDF

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Case Study Chapters 4, 5...

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Dr. Kim 11/11/2014 Case Studies: Chapters 4 and 5

Chapter 4: Blades, Inc. Assessment of Future Exchange Rate Movements Case Summary: CFO, Ben Holt of Blades Inc. has been exporting “Speedos” to Thailand and has raised some concerns regarding the local currency. A loss in confidence from investors could result in the weak economy of Thailand to have negative repercussions on the company’s profitability in the country. These repercussions affect the currency (baht), which can hurt the company in the future regarding the exchange rate from baht to dollars.

1 .Ho wa r ep e r c e n t a g ec h a n g e si nac u r r e nc y ’ sv a l ueme a s u r e d?I l l u s t r a t ey o u ra n s we r n ume r i c a l l yb ya s s u mi n gac h a n g ei nt h eTh a ib a h t ’ sv a l u ef r o m ava l ueo f$ . 02 2t o$ . 0 2 6 . Cu r r e n c y ’ sv a l u ec a nb eme a s u r e df o rp e r c e nt a g ec h a n g e su s i n gt h eb e l o wf o r mu l a : % ∆=

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2 .Wh a ta r et heb a s i cf a c t o r st h a td e t e r mi net hev a l u eo fac u r r e n c y ?I ne q u i l i b r i u m,wh a ti s t her e l a t i o n s h i pb e t we e nt h e s ef a c t o r s ? Th ev a l u eo fac u r r e n c yc a nb ed e t e r mi n e db yt wof u n d a me n t a lf a c t o r s , u s e di n ma n ye c o no mi ca p p l i c a t i o n s ,wh i c ha r et h es u p p l yo ft hec u r r e n c ya n dt h ed e ma n d f o rt hec ur r e n c y . Asof t e nt h ec a s ewi t ha ni n c r e a s ei ns u p p l y , t h ev a l ueo ft h e g o o d / s e r v i c e( i nt h i sc a s ec u r r e n c y )wi l ld e c r e a s ei nv a l u e . Co n t r a r i wi s e , i ft he r ei sa h i g hd e ma n df o rc u r r e n c yt h eo p p o s i t eh o l d st r ue ;t hec u r r e n c ywi l lo f t e ni n c r e a s e i nv a l u e . I ne q ui l i b r i u m, t h es u pp l yo fc u r r e n c ya n dd e ma n df ort h ec u r r e n c ywi l l e q ua lo n ea n o t h e r .

3 .Ho wmi g h tt h er e l a t i v e l yh i g hl e v e l so fi n fla t i o na n di nt e r e s tr a t e si nTh a i l a n da ffe c tt h e b a h t ’ sv a l u e ?( As s u meac o n s t a n tl e v e lo fU. S.i n fla t i o na n di n t e r e s tr a t e s . ) Gi v e nt h ec o n s t a n tl e v e lo fU. S. i nfla t i o na n di n t e r e s tr a t e s ,t heb a ht ’ sv a l uewo ul d b eg r e a t l ya ffe c t e di nTha i l a n d . Asi st y p i c a lf orh i g hl e v e l so fi nfla t i o n , Th a i l a n d wi l ls e ei t sc u r r e n c yd e p r e c i a t ei nv a l u e . Du et ot hi sde p r e c i a t i o n ,Th a i l a n dwi l la l s o s e ea ni n c r e a s ei nd e ma n df o rU. S. g o o d s . Th i swo u l d ,i nt u r n ,c a u s ea ni n c r e a s ei n t heTha id e ma n df ord o l l a r s . Wh e ne x a mi n i n gar e l a t i v e l yh i g hl e v e lo fi n fla t i o ni n Th a i l a nd ,t h eo p p o s i t eoc c u r s . TheU. S. wo u l dr e d u c ei t sd e ma n df o rTh a i g oo d s ,

whi c hwo u l dr e s u l ti na ni n c r e a s ei ns u pp l yf o rt heTh a iBa h t . Ho we v e r , t h i si so nl y o n eo ft woe c o no mi co u t c o me s .

Ah i g hl e v e lo fi n t e r e s tr a t ei nTh a i l a n da l s oh a st h ep ot e n t i a l t or e s u l ti nt h eb a ht a p p r e c i a t i n gi nv a l u e( r e l a t i v et ot h ed o l l a r ) . U. S. i n v e s t o r swo u l dh a v eb e e nmo r e a t t r a c t e dt oTh a i l a n di nt e r mso fi n v e s t me n t . Th ei n c r e a s ei nU. S.i n v e s t o r si nt h e Th a ima r k e two u l dc a u s et hed e ma n df o rb a h tt oi n c r e a s ea swe l l . Ad d i t i o n a l l y , t h e s u p p l yo fd o l l a r swou l da l s oi n c r e a s e ,a sTh a i l a n d ’ si n v e s t o r swo ul dbel e s sa t t r a c t e d t oU. S. i n v e s t me n t se . g . s e c u r i t i e s . Gi v et h e s ef a c t or s ;U. S. i n v e s t o r smi g hts t i l lb e r e l u c t a n tt oi n v e s ti nTh a i l a n d ’ ss e c u r i t i e s . Th ei d e aoft h eb a h td e p r e c i a t i n gi nv a l u e d u et oTh a i l a n d’ si n fla t i o nma yb ec a u s ef o rU. S. i n v e s t o r st or e c o n s i d e ri n v e s t i n gi n Th a i l a nd .

4 .Ho wdoy o ut h i n kt h el o s so fc o n fid e n c ei nt h eTha ib a h t , e v i d e n c e db yt h ewi t h d r a wa lo f f u n d sf r omTh a i l a n d ,wi l la ffe c tt heb a h t ’ sv a l u e ?Wo u l dBl a d e sb ea ffe c t e db yt h ec h a n g e i nv a l u e , g i v e nt h ep r i ma r yTh a i c u s t o me r ’ sc o mmi t me n t ? Asi st h ec a s ewi t hma n yc u r r e n c i e s , t hel o s si nc on fid e n c ei nt h eTh a i b a h two u l d c a u s ead e p r e c i a t i o ni ni t sv a l u e . Whe nt h e r ei sal o s so fc o n fid e n c e , i tc a nb es a i d t ha ti n v e s t o r sa r en o ts a t i s fie dt ha tt h e i ri n v e s t me n t swi l lp r o v el uc r a t i v ei nt h e c u r r e n tma r k e t . I nwh i c hc a s e ,i n v e s t o r swi l lo f t e nl i q ui d a t et h e i ri n v e s t me n t si nt h e ma r k e t . Th es a meh o l dst r u ef o rTh a i l a n d ’ sba ht . I n v e s t o r swi l ll i q u i d a t et he i r i n v e s t me n t si nt h eb a h t , wh i c hwi l lc a u s et h es u p p l yo ft h eb a h tt oi nc r e a s ei nt h e ma r k e t .

Bl a de swou l da l s ob eg r e a t l ya ffe c t e db yt h ec ha n g eo fv a l uei nTh a i l a n d ’ sc u r r e n c y . Th es a l e sf o rt hec o mp a n ya r ehe l d , f o rt h ema j o r i t y , i nt h ef o r e i g nc ur r e n c yb a h t . As p r e vi o u s l ya f o r e me n t i o n e d ,wh e nt h e i ri n c r e a s ei nt h es up p l yo fb a h ti nt h ema r k e t , t hep r i c ef o rt h eb a h td e p r e c i a t e s . Th ec o mp a n yi sn o wa tal o s si np r o fitb e c a u s eo f t hen e we x c h a n g er a t e . Th ec o mp a n ywi l lr e c e i v el e s si nt e r msofU. S. do l l a r sf o rt he e x c h a n g eo ft h e i rb a h t .

5 .As s u met h a tTh a i l a nd ’ sc e nt r a l b a n kwi s h e st op r e v e n tawi t h d r a wa lo ff u n dsf r o mi t s c o u n t r yi no r d e rt op r e v e n tf u r t h e rc ha n g e si nt h ec u r r e n c y ’ sv a l u e .Ho wc ou l di t a c c o mp l i s ht h i so b j e c t i v eu s i n gi n t e r e s tr a t e s ? I fTh a i l a n d ’ sc e n t r a lba n ki sl o o ki n gt op r e v e n ta n yf u r t h e rwi t h dr a wa lo ff u nd s f r o mt h ec o u n t r y , i ti sl o o ki n gt os t o pt h ed e p r e c i a t i o ni nt h eb a ht . I nor de rt od os o , Th a i l a ndwo u l dh a v et oi n c r e a s et h ei n t e r e s tr a t e swi t hi nt hec o u n t r y . Th i swo u l d c a u s ei n t e r n a ls p e n di n go rb o r r o wi n gt od e c r e a s e , b utTha i l a n d ’ si n v e s t me n t s( e . g . s e c u r i t i e s )wo u l dn o wb e c omemo r ea p p e a l i n gt oU. S.i n v e s t o r s .Ha v i n gt h i si nflu x o fU. S. i n v e s t o r swo u l dc a u s ed e ma n df o rt h eb a h tt oi n c r e a s e .Th ede ma n df o rt h e b a h two u l dc a u s ei t sv a l u et oi n c r e a s e( a p p r e c i a t e )a n dwo u l ds o l v et h ep r o b l e mo f f u nd sb e i n gwi t h d r a wnf r o mt h ec o u n t r y .

6 .Con s t r u c tas pr e a d s h e e ti l l u s t r a t i n gt h es t e p sBl a d e s ’t r e a s u r e rwo u l dn e e dt of ol l o wi n o r d e r t os p e c u l a t eo ne x p e c t e dmo v e me n t si nt h eb a h t ’ sv a l u eo v e rt h en e x t3 0d a y s .Al s o s h o wt h es p e c u l a t i v ep r o fit( i nd ol l a r s )r e s u l t i n gf r o me a c hs c e n a r i o . Us eb o t hofBe nHo l t ’ s e x a mp l e st oi l l us t r a t ep o s s i b l es p e c u l a t i o n .As s u met h a tBl a d e sc a nb or r o we i t h e r$ 1 0 mi l l i o no rt h eb a hte q u i v a l e n to ft h i sa mo u n t . Fu r t h e r mor e , a s s u met h a tt h ef o l l o wi n gs h o r t t e r mi n t e r e s tr a t e s( a n n u a l i z e d )a r ea v a i l a b l et oBl a d e s :

Cur r e nc y

Le ndi ng

Bo r r o wi ngRa t e

Ra t e Dol l a r s

8 . 1 0 %

8 . 2 0

Th a ib a h t

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Chapter 5: Blades Inc. Case Use of Currency Derivative Instruments

Summary of the case: Blades Inc. is looking to order supplies for the company 2 months ahead of the delivery. With this time, Blades Inc. is trying to decide as to whether they should pursue purchasing options or futures. Given the distinct advantages of either options or futures, paired with the volatility of the Japanese yen in the market, it can go either way. Traditionally, Blades Inc. CFO has preferred options because of their flexibility, something futures contracts lack. However, due to a recent event, the yen’s future has become even more uncertain, which is raising the question of which direction the company should take in terms of options or futures.

1 .I fBl a de su s e sc a l lo p t i o n st oh e d g ei t sy e npa y a bl e s , s h o u l di tu s et h ec a l lop t i o nwi t ht h e e x e r c i s ep r i c eo f$ . 0 07 5 6o rt h ec a l lo p t i o nwi t ht hee x e r c i s ep r i c eo f$ . 0 0 7 92 ?De s c r i b et h e t r a d e o ff. Gi v e nt h ei nf or ma t i o np r o v i d e di nt het a b l e , Bl a d e sI n c . i sl e f twi t ho n eo ft wo o p t i o n s . I fBl a d e sI n c . c o nt i n u e st ou s eo p t i o n s ;i twi l le i t h e rh a v et oa c c e p tah i gh e r e x e r c i s ep r i c e( ma yl i mi th e d g e )o rah i gh e rp r e mi um ( mo r et h a ni tp r e f e r s ) . As s u mi n gBl a d e sI n c .d o e sn o twa n tt op a ya n y mo r et h a nt h e5 %a b o v et h es po t r a t e , t h a nt h ec o mp a n ys h o u l dg i v ec o n s i d e r a t i o nt ot heo p t i o nwi t ht h ee x e r c i s e p r i c eo f$ 0 . 0 07 5 6 . Wi t ht hi sp r i c eh o we v e r , t hec o mp a n yn o ws u b j e c t st h e ms e l v e st o

t heh i g h e rp r e mi u mont heo p t i o n( 2 %o ft h ee x e r c i s ep r i c e ) .

Co n v e r s e l y , Bl a d e sI n c . c o u l dc o n s i de rb u yi n ga na l t e r n a t i v eo p t i o nwi t hal o we r p r e mi u m.Ho we v e r , c h o o s i n gt h eo p t i o nwi t ht h ee x e r c i s ep r i c eo f$ 0 . 0 0 7 9 2wo u l d r e s u l ti nt h ec o mp a n yp a y i n g1 0 %a b o v et h ee x i s t i n gs p o tr a t e . Thi so p t i ona l s o a ffe c t st hes t a n da r dt h a tBl a d eI n c . a b i d e sb ywh e ni tc o me st ot hes p o tr a t e . Wi t h t hi so p t i o n, t h ec o mp a n ywo u l db ep a y i n gmo r et h a n5 %a b o v et h ee x i s t i n gs p ot r a t e .

I ft h ed e c i s i o nt ou s ea no p t i on ss t a n d sf o rBl a de sI n c .t ha nt h et r a d e o ffwo u l db ea s f o l l o we d . Th ec o mp a n yc a np a yap r e mi u mo f$1 , 4 17 . 50t ol i mi tt h ea mo u n tof p a y a b l e st o$ 9 9 , 0 0 0o rt h ec o mp a n yc a np a yap r e mi umo f$ 1 , 8 9 0t ol i mi tt h e a mo u nto fp a y a b l e st o$ 94 , 5 00 . Op e r a t i n gu nd e rBl a de sI n c . , i two u l db eb e s tt o c h oo s eah i g h e rp r e mi u mt op a yf o rt h el o we rl i mi to np a y a bl e s .

2 .Sho u l dBl a d e sa l l o wi t sy e np o s i t i o nt ob eu n h e d g e d ?De s c r i b et h et r a d e o ff. Th ema r k e tv ol a t i l i t ywa s( a nds t i l li s )t h ed r i vi n gf o r c eb e h i n dBl a d e sI n c . c h o o s i n g t oh e d g eo v e rt h eo p t i o nt ou n h e d g e . Be f o r et hee v e n te v e no c c u r r e d , t hema r k e t wa sp r o v i n gv ol a t i l ei ni t smo v e me n t sa n db e c a u s eo fwh i c h ,i tc a u s e du n c e r t a i n t y a b o u tt h ey e n ’ sf u t u r ev a l u e . Asar e s u l to ft h ee v e n t ,t h e r ei se v e nmo r eu nc e r t a i n t y a b o u tt h ey e n ’ sf u t u r ev a l u e . Gi v e nBl a d e sI n c . i n v ol v e me n tp r i o rt ot h ee v e n t , i t g o e swi t h o u ts a y i n gt h a tt h ec o mp a n ywoul dh a v ee n g a g e di nh e d g i n ge v e na f t e rt h e e v e n t .

Ap o s s i b l ea l t e r n a t i v et oo p t i o n swo ul db ef o rBl a d e sI n c . t oc o n s i d e rf u t u r e s c o n t r a c t s . Af t e rt h ee v e n t , wh e nu n c e r t a i n t yi n c r e a s e dwi t h i nt h ema r k e t , t h ep r i c e f o rf ut u r e sr e ma i n e dt h es a me( u n a ffe c t e d ) . Gi v e nt h eflu c t u a t i o n st h a to pt i o n s u n de r we n t , Bl a d e sI n c . s h o u l dg i v es o met ho u g h tt ot hei d e ao fu s i n gf u t u r e s c o n t r a c t si n s t e a dofo pt i o n s . Si n c et h ep r i c e ss t a y e dt h es a mef o rf u t u r e s , Bl a d e sI nc . c o u l db u yf u t u r e sc o n t r a c t sa t t h es a mer a t ea st h e ywe r eb e f or et h ee v e n ta n d s o l i di f yi t sf ut ur ep a y me n t .

3 .As s u met h e r ea r es pe c u l a t o r swh oa t t e mp tt oc a p i t a l i z eo nt h e i re x p e c t a t i o noft h ey e n ’ s mo v e me n to v e rt h e2mo n t hsb e t we e nt h eo r d e ra ndd e l i v e r yd a t e sb ye i t h e rb u y i n go r s e l l i n gy e nf u t u r e sn o wa n db u y i n go rs e l l i n gy e na tt h ef u t u r es p o tr a t e . Gi v e nt h i s i nf or ma t i o n , wha ti st h ee x p e c t a t i o no nt h eor de rd a t eoft h ey e ns p o tr a t eb yt h ed e l i v e r y d a t e ?( Yo u ra n s we rs h o ul dc o n s i s to fo n en u mb e r . ) Th ee x p e c t a t i o no ft h ef u t u r es p o tr a t e ,g i v e nt h a ts p e c u l a t o r sa r ea t t e mp t i n gt o c a p i t a l i z eo nt h ey e n ’ sf u t ur emo v e me n t , wo u l db ee q ua lt ot h ef u t u r e sr a t e . Th a t b e i n gs a i d ,t h ef u t u r es p o tr a t ea n dt h ef u t ur e sr a t ewo u l de q u a l $0 . 0 06 9 1 2 . Th e r e a s o n i n gb e h i n dt hi ss t e msf r o mt h ef a c t o r st h a tt a k ep l a c eg i v e nt h es p e c u l a t o r s ’ e x p e c t a t i o n s . Us i n gt hee xp e c t a t i ono ft h ea p pr e c i a t i o noft h ey e na sa ne x a mpl e , t h e s p e c u l a t o r sa c t i on sd e t e r mi n eh o wt h ef u t u r e sr a t ea n dt h ef u t u r es p o tr a t ee q u a l o n e a n o t he r . Du et ot h ea p pr e c i a t i o n , s p e c u l a t o r swo u l db u yy e nf u t u r e sn o wa n di ft h e y e na p pr e c i a t e s , t h e ya l s ob u yt h ey e na t t h ef u t u r e sr a t e . Af t e rwhi c h , t h e ywi l ls e l l t he ma tt h es p o tr a t e( 2mo nt h s ) . Ha v i n ga l lt h e s es p e c u l a t o r sd o i n gt h es a met h i n g a tt h es a met i mewi l lc a u s et h ef u t u r e sr a t et oi n c r e a s ea n dd e c r e a s et h ee x p e c t e d f u t u r es p otr a t eu n t i lt he yb e c omee q u a l .

4 .As s u met h a tt hefir ms h a r e st hema r k e tc o n s e n s u so ft h ef u t u r ey e ns p o tr a t e . Gi v e nt h i s e x p e c t a t i o na n dg i v e nt h a t t h efir mma k e sad e c i s i o n( i . e . , $ . 00 69 12 )o p t i o n ,f u t u r e sc o n t r a c t , r e ma i nu n h e dg e d )p ur e l yonac o s tb a s i s , wh a two u l db ei t so pt i ma lc h o i c e ? As s u mi n gt h ed e c i s i o ni sb a s e de n t i r e l yo nac o s tb a s i sa n du t i l i z i n gt h ed a t a p r o v i de di nt h ea f or e me n t i o n e dpr ob l e m, t h eo p t i ma lc h o i c ewo u l db et ob u yo ne f u t u r e sc o n t r a c t . Th i sp u r c h a s ewo ul dh a v ea no u t c o meof$ 86 , 4 00f o rt h ea c t u a l c o s to nt h ed e l i v e r yd a t e . Thes a mec a na l s obes a i df o rt h eu nh e d g e da l t e r n a t i v e , whi c hwo u l dr e s u l ti nt h es a mea c t u a lc o s to nt h ede l i v e r yda t e .Ho we v e r , t h e c o mp a n ywi l lmo s tl i k e l yc h o os et h ef u t u r e sc o n t r a c ta l t e r n a t i v et or e ma i ni n gu n h e d g e d .Re ma i n i n gu n h e d g e d , t h ey e nmo v e me n t sb e t we e nt h eo r d e rd a t ea n dt h e d e l i v e r yd a t ema yc a u s et hea c t u a l c o s t si nc ur r e dont h ed e l i v e r yd a yt op u r c h a s ey e n t od i ffe rr a d i c a l l yf r o mt heo r i g i n a l$ 8 6 , 4 0 0 .

5 .Wi l lt h ec ho i c ey o uma d ea st ot h eo p t i ma lh e d g i n gs t r a t e g yi nq ue s t i on4d e fin i t e l yt u r no u t t ob et h el o we s t c o s ta l t e r na t i v ei nt e r mso fa c t ua lc o s t si nc u r r e d ?Wh yo rwh yn o t ? Th ec h o i c ema d ei nq u e s t i o n4wi l ln o tr e s u l tt ob et hel o we s t c o s ta l t e r n a t i v e .Th e J a p a n e s ec u r r e n c y( y e n )h a sp r o v e nt ob ev ol a t i l ei nt h ema r k e ta n dha dt h ep ot e n t i a l t or e s ul ti nt h ea c t u a lc os t si n c u r r e dt ob el o we ri ft h efir mh a dc h o s e nt or e ma i nu n h e d g e do rt ohe d g et h ey e np a y a b l e . Ha v i n gc h o s e nt h ef u t ur e sc o n t r a c ta l t e r n a t i v e , t hec o mp a n yi sf o r c e di nt ot h ep r i c ei twi l lp a yt op u r c ha s et h ey e na tt hed e l i v e r y d a t e . Asar e s u l t ,t hec o mp a n yr e l i nq u i s h e sa n yc os ta d v a n t a g et h a tma ya r i s ef r o m t hed e p r e c a t i o no ft h ey e nb yt h ed e l i v e r yd a t e . Gi v e nt hi si n f o r ma t i o n ,t h e a l t e r na t i v et or e ma i nu nhe d g e da n du s i n go p t i o n sa l l o wt h ec omp a n ys o meo ft h e e l a s t i c i t yn e e de dt ob u yy e na tt h es p o tr a t e ,wh i c hi sn o to ffe r e dt h r o u g haf u t u r e s

c o n t r a c t .

6 .No wa s s u met h a ty o uh a v ede t e r mi ne dt h a tt h eh i s t o r i c a ls t a n d a r dd e v i a t i o no ft h ey e ni s a b o u t$ . 0 0 0 5 . Ba s e dony o u ra s s e s s me n t , y o ub e l i e v ei ti shi g h l yu n l i k e l yt h a tt hef u t u r e s p o tr a t ewi l lb emo r et ha nt wos t a n d a r dd e v i a t i o nsa b o v et h ee x pe c t e ds p o tr a t eb yt h e d e l i v e r yd a t e . Al s oa s s umet ha tt h ef u t u r e sp r i c er e ma i nsa t i t sc u r r e n tl e v e lo f$ . 0 0 6 9 12 . Ba s e do nt h i se x p e c t a t i o no ft h ef u t u r es p o tr a t e ,wh a t i st h eo p t i ma lh e d g ef ort h efir m? Pr o v i d e dt h ef u t u r e sr a t er e ma i n sa t i t sc u r r e n tp o i n ta n dt h ee x p e c t e ds p o tr a t ea t t hed e l i v e r yda t ei n c r e a s e s( n o th e d g e d ) ,i twi l lb e c o mei n c r e a s i n g l ymo r ee x p e n s i v et h a n h e d g i n gwi t haf u t u r e sc o n t r a c t . Mo r e o v e r , t h eo p t i o nwi t ht h ee x e r c i s ep r i c eo f$ 0 . 0 0 7 56 wo ul da l s ob ee x e r c i s e d . Th i s , h o we v e r , h ol d sl i t t l ewe i g h tg i v e nt h es p r e a d s h e e t . Op t i o ns1 a n d2b o t hh a v ea ne x e r c i s ep r i c eg r e a t e rt ha nt hef u t u r e sr a t eo f$ 0 . 0 0 6 9 12 . Ad d i t i o n a l l y , t hee xp e c t e df u t u r es p o tr a t ei sa l s ogr e a t e rt h a nt h ef u t u r er a t e , wh i c hma k e st h ef u t u r e s c o n t r a c tt h eb e s ta l t e r n a t i v ef o rt h ec o mp a n y ....