Dozier industries - Rothschild can utilize the money market hedge technique in this situation. Under PDF

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Rothschild can utilize the money market hedge technique in this situation. Under this strategy, the balance of $1057500 will be charged to the British firm at the rate of 1.5%....

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Running head: DOZIER INDUSTRY

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Dozier Industries Case Study Name of student Institution

DOZIER INDUSTRY

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Decision making remains crucial for the success of all businesses. Decision makers in such businesses often find themselves in dilemmas that involve quite critical decisions. In this case, Rothschild finds himself in a dilemma that requires that he decides on the bid for the contract he just made with Southeastern National Bank. Upon engaging John Gunn, the international specialist of financial matters, Rothschild quickly became aware what options contract might benefit them with. Rothschild can utilize the money market hedge technique in this situation. Under this strategy, the balance of $1057500 will be charged to the British firm at the rate of 1.5%. This means that the company will need to borrow the $1057500 to pay this amount. The company will then have to translate this money at the rate of $1.4370 per pound as offered on 14th of January. Thereafter, the funds will be invested at 8% annual rate in the United States. This will enable the company to repay the loan it had taken. Conveniently, this would have billed about three months after the British company paid Dozier on the current day. The profit obtained from this project would be calculated by adding the 10% deposit that had been paid on January 13th and which had been invested in the US dollars to the value of the money borrowed. This would then be converted to dollars and invested in the US. Dozier would be able to make a net profit of approximately 1.73% using the approach. Overall, the company would be able to make a profit of about $162899 using this forward contract approach. Similarly, the company would expect to make a minimum gain of about $162469 using this strategy. However, the company can only get the maximum and minimum earnings if the currency remains above $1.45 per ounce and $1.15 per ounce respectively. In both

DOZIER INDUSTRY

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cases, these rates would lie between the call and position strike values. This means that the company would not make a loss on its calls and not benefit from its put options. A quick look at the company’s situation on December 3rd 1985 reveals that the hedging with a forward contract may have likely resulted in a potential advantage of -18289 during the time. On the other hand, if the firm decides to hedge through the options strategy, the company would be assured of attaining their target profit margin of 6% or higher. This strategy may however, lead to minimal gross profit of approximately 9.66% for the company.

Hedge in the Money Market Forward contract: Borrow (amount in pounds): -0.012% gain/loss Amount in pounds : 1, 057,500 Convert to $ Forward rate1\4\86 1.4298$ per pound Unhedged value 1529628 Liability on 4/14/86 1501448.5 -18289 benefit or loss opportunity

Set options Purchase contracts; bank stocks Each choice 1200 Margin of profit 6% At the time of the offer, the exchange rate was 1.485 each pound Strike price as close as possible 1.495 each pound Due date March Cost of a premium 0.034 Purchase contracts 85.0 The overall cost will be: 46850 Total amount that can be received 1534375 Total income 1704524 Total price 1541625 Earnings 163899 Return on investment 9.57%

DOZIER INDUSTRY Call options Purchase contracts; bank stocks 12500 each Margin of profit 6% At the time of the offer, the exchange rate was 1.495 each pound Strike price as close as possible 1.5 per pound Cost of a premium 0.009 per contract Purchase agreements 85 contracts Profit 9672.49 If the currency values reach at 1.5% Obtainable 1588360 Total earnings 1757499 Total value 1584750 Gross earnings 161659 Margin of profit 10.35%

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