EFB312 International Finance Assignment PDF

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Jonah Wat

EFB312

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EFB312 International Finance Assignment Part A Question 1 The American Institute for Foreign Study (AIFS) is a travel and insurance company for a range of people around the world. They offer services such as au pair placements, overseas study opportunities for college and high school students and programs for gifted learners, amongst others. AIFS provides these services through two main programs, the High School Travel Division and the Study Abroad College Division. AIFS plays their part by providing organised services and insurance for all the student’s needs, making overseas study accessible and streamlined. AIFS provides these services to approximately 50,000 participants per year and has stretches to 29 different countries worldwide. A summarised diagram of the AIFS business structure is found below.

Study abroad programs

1 to 4 week organised trips

AIFS

High School Students

$

Utilisation of services

Services for AIFS packages

$

$

College Students Utilisation of services

International Services (Colleges, Accommodation, Transport, etc.)

Question 2 a) The AIFS’ decision to hedge all of its costs may not be an optimal strategy for the corporation as the decision is made based on forecasted sales volumes and future exchange rates, which are both unknown. This makes it a risky strategy and is not consistent with the firm’s goals of reducing risks such as competitive pricing and botom-line risk. b) Hedging one hundred percent of costs in a business to reduce volatility risk and stabilise earnings is a valuable idea that could greatly benefit AIFS, however using an option hedge rather than a forward contract is recommended. The benefits of an

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options contract are that the firm will be able to not follow through with the contract if the outcome is not in their best interest, whereas a forward contract will legally lock in the firm regardless of their future best interests. If the firm were to buy options instead of forward contracts and the most appropriate decision is to not engage the contract, this would come at the small price of a premium fee. Another feature of an options contract that would be beneficial for AIFS is that the riskiness of buying a forward contract based on unknowns such as future sales forecasts and predicted price changes is minimalised. This is because if sales increase or decrease, the firm will have the right to either call or put respectively based on the now known statistics. A final benefit of an options contract is that AIFS may use the agreement to buy currency, which could be done at either the agreed strike rate or the spot rate, depending on which will favour the firm more. To summarise, hedging the firm’s costs by using an options contract instead of a forward contract would be a more desirable strategy as it will give the firm the freedom to exercise or dismiss the contract without the unknowns factor risk.

Question 3 a) The primary social responsibility of any company that decides to issue equity to a public market is to maximise shareholder value. This means all decisions should be made with the shareholders’ best interests in mind while also abiding by the firm’s other objectives and social responsibilities. b) The AIFS’ decision to potentially pursue an overseas venture in New Zealand would have both positive and negative effects on the firm, especially if their equity is issued to the NYSE. Some prominent negative effects would be the loss of local employment, which could dishearten the local employees and tarnish the firm’s reputation, leading to a potential loss of investment. Potential benefits of this decision include firstly increasing international employment and even provide opportunities for current employees to work abroad; secondly increase brand awareness in New Zealand which could lead to a potential increase in investment when the firm goes public. Therefore, the firm’s idea for a New Zealand business venture has moderate costs and benefits associated with it that should be considered before making a final decision.

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EFB312

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Part B Relevant information: Current Exchange Rate Forward Rate Expected Final Volume

Cost per Student Option Premium Option Strike Price

$1.16/€ $1.185/€ 10,000 (worst) 30,000 (expected) 36,000 (best) €2,500 2% of USD strike price $1.165/€

Question 4 a) Total projected costs are as follows:

Formul a Value

Worst Case Scenario 10,000∗€ 2,500∗1.16

Expected Scenario 30,000∗€ 2,500∗1.16

Best Case Scenario 36,000∗€ 2,500∗1.16

€ 25 mil ∨$ 29 mil

€ 75 mil∨$ 87 mil

€ 90 mil∨$ 104.4 mil

b) Total costs using a forward contract to hedge are as follows:

Formul a Value

Worst Case Scenario 10,000∗€ 2,500∗1.185

Expected Scenario 30,000∗€ 2,500∗1.185

Best Case Scenario 36,000∗€ 2,500∗1.185

€ 25 mil∨$ 29.625mil

€ 75 mil∨$ 88.875mil

€ 90 mil∨$ 106.65 mil

c) Total Option premium values are as follows:

Formul a Value

Worst Case Scenario Expected Scenario Best Case Scenario 10,000∗€ 2,500∗1.165∗2 30,000∗€ 2,500∗1.165∗2 36,000∗€ 2,500∗1.165∗ € 500 k ∨$ 582.5 k

€ 1.5 mil ∨$ 1.7475 mil

€ 1.8 mil ∨$ 2.097 mil

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EFB312

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Question 5 a) Baseline scenario: 30,000∗€ 2,500∗1.16=$ 87 million b) Increased exchange rate: 30,000∗€ 2,500∗1.25=93.75 mil($ 6.75 mil increase) c) Decreased exchange rate: 30,000∗€ 2,500∗1.08=$ 81 mil ($ 6 mil decrease)

Question 6 Projected Costs ($) ¿ Sales volume∗Cost per Student (€ )∗Forward Rate Projected Costs ($) ¿ 30,000∗€ 2,500∗1.185=$ 88.875 million a) Exchange rate at $1.16/ € : 30,000∗€ 2,500∗1.16 =$ 87 million ( 1.875 mil decrease ) 1.875 =2.11 % decrease Percentage change: 88.875 Since there is a 2.11% decrease in the cost if we do not use the forward rate, it is more beneficial to use the spot rate and not hedge using a forward contract. b) Exchange rate at $1.25/ € : 30,000∗€ 2,500∗1.25=$ 93.75 million( $ 4.875 mil increase ) 4.875 =5.49 %increase Percentage change: 88.875 Since there is a 5.49% increase in the cost if we do not use the forward rate, it is more beneficial to use the forward rate in this situation. c) Exchange rate at $1.08/ € : 30,000∗€ 2,500∗1.08=$ 81 million ( $ 7.875 milde crease ) 7 .875 =8.86 %de crease Percentage change: 88.875 Since there is an 8.86% decrease in the cost if we do not use the forward rate, it is more beneficial to use the spot rate instead of the forward rate.

Question 7 As the CFO, we have decided to use the option rates to hedge our costs. Therefore, a premium of 2% will be added to all costs, regardless of if the option is used. Projected Costs ($) ¿ Sales volume∗Cost per Student ( € ) ∗Option Rate+ Premium As we have already calculated the premium for a sales volume of 30,000 ($1.7475 mil), we can substitute this value into the equation.

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Projected Costs ($) ¿(30,000∗€ 2,500∗1.16 5)+1.7475 mil=$ 89.1225 million a) Exchange rate at $1.16/ € : 30,000∗€ 2,500∗1.16 (+$ 1.7475mil )=$ 88.7475 million ( 0.375 mil decrease ) 0.375 =0.42 %decrease Percentage change: 89.1225 Since there is a 0.42% decrease in the cost if we do not use the option strike rate, it is more beneficial to use the spot rate and not hedge using an options contract. However, the premium ($1.7475 mil) will still have to be paid. b) Exchange rate at $1.25/ € : 30,000∗€ 2,500∗1.25 (+$ 1.7475 mil)=$ 95 . 49 75 million ( 6 .375 mil ∈ crease ) 6.375 =7.15 %∈crease Percentage change: 89.1225 Since there is a 7.15% increase in the cost if we do not use the option strike rate, it is more beneficial to use the option strike rate previously agreed upon. c) Exchange rate at $1.08/ € : 30,000∗€ 2,500∗1.08 (+$ 1.7475mil)=$ 8 2 .7475 million ( 6.375 mil decrease ) 6.375 =7.15 %decrease Percentage change: 89.1225 Since there is a 7.15% decrease in the cost if we do not use the option strike rate, it is more beneficial to use the spot rate and not hedge using an options contract. However, the premium ($1.7475 mil) will still have to be paid.

Question 8 To assess the most profitable strategy for each exchange rate, we will gather the costs we have calculated in previous questions and compare. a) Exchange rate at $1.16/ € : No hedge (spot rate) cost Forward contract cost Option contract cost

= $87 million = $88.875 million = $89.1225 million

Therefore, the most profitable strategy for this particular spot rate is to not hedge and simply use the current spot rate. This is because the spot rate is lower than both contract rates, making it the cheapest option.

b) Exchange rate at $1.25/ € :

Jonah Wat No hedge (spot rate) cost Forward contract cost Option contract cost

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= $93.75 million = $88.875 million = $89.1225 million

Therefore, the most profitable strategy would be to use a forward contract in this situation, as the agreed rate is lower than the current spot rate and does not include an added premium, making it the cheapest option. c) Exchange rate at $1.08/ € : No hedge (spot rate) cost Forward contract cost Option contract cost

= $81 million = $88.875 million = $89.1225 million

Again, the best option here would be to use the current spot rate as it is significantly lower than both of the agreed contract rates, making it by far the cheapest option. d) Statistically, the best strategy would be to not hedge the firm’s costs and use the current spot rate as it is the preferred option two out of three times, as seen above. The option contract gives the firm flexibility by having the option to retract the deal, but this comes at the expense of a premium which makes an option contract too expensive. A forward contract would only be recommended if the forecasted spot rate is anything over $1.185/ € , which was $1.25/ € in this case....