Foreign exchange exercises PDF

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ABC Industries Problems 1 through 4 are based on ABC Industries. ABC is a U.S.-based multinational manufacturing firm, with wholly owned subsidiaries in Brazil, Germany, and China, in addition to domestic operations in the United States. ABC currently has 650,000 shares outstanding. The basic operating characteristics of the various business units is as follows: U.S. Parent Company Business Performance (000s, loccal currency) Earnings before taxes (EBT)

(US$)

Brazilian Subsidiary (reais, R$)

German Subsidiary (euros, €)

Chinese Subsidiary (yuan, Y)

$4,500

R$6,250

€ 4,500

Y2,500

Corporate income tax rate

35%

25%

40%

30%

Average exchange rate for the period

-

R$1.80/$

€0.7018/$

Y7.750/$

Problem 1.ABC ABC must pay corporate income tax in each country in which it currently has operations. a. After deducting taxes in each country, what are ABCs consolidated earnings and consolidated earnings per share in U.S. dollars? b. What proportion of ABCs consolidated earnings arise from each individual country? c. What proportion of ABCs consolidated earnings arise from outside the United States?" Problem 1.2 ABCs Sensitivity to Exchange Rates (A) Assume a major political crisis wracks Brazil, first affecting the value of the Brazilian reais and, subsequently, inducing an economic recession within the country. What would be the impact on ABCs consolidated EPS if the Brazilian reais were to fall in value to R$3.00/$, with all other earnings and exchange rates remaining the same? Problem 1.3 ABCs EPS Sensitivity to Exchange Rates (B) Assume a major political crisis wracks Brazil, first affecting the value of the Brazilian reais and, subsequently, inducing an economic recession within the country. What would be the impact on ABCs consolidated EPS if, in addition to the fall in the value of the reais to R$3.00/$, earnings before taxes in Brazil fell as a result of the recession to R$5,8000,000?

Problem 1.4 ABCs Earnings and the Fall of the Dollar The U.S. dollar has experienced significant swings in value against most of the world's currencies in recent years. a. What would be the impact on ABCs consolidated EPS if all foreign currencies were to appreciate 20% against the U.S. dollar? b. What would be the impact on ABCs consolidated EPS if all foreign currencies were to depreciate 20% against the U.S. dollar?

Problem 2 Toyota Exports to the United Kingdom Toyota manufactures most of the vehicles it sells in the United Kingdom in Japan. The base platform for the Toyota Tundra truck line is ¥1,650,000. The spot rate of the Japanese yen against the British pound has recently moved from ¥197/£ to ¥190/£. How does this change the price of the Tundra to Toyota's British subsidiary in British pounds?

Problem 3 Loonie Parity If the price of former Chairman of the U.S. Federal Reserve Alan Greenspan’s memoir, "The Age of Turbulence," is listed on Amazon.ca as C$26.33, but costs just US$23.10 on Amazon.com, what exchange rate does that imply between the two currencies?

Problem 4 Hong Kong Dollar and the Chinese Yuan The Hong Kong dollar has long been pegged to the U.S. dollar at HK$7.80/$. When the Chinese yuan was revalued in July 2005 against the U.S. dollar from Yuan8.28/$ to Yuan8.11/$, how did the value of the Hong Kong dollar change against the yuan?

Problem 5 Ranbaxy (India) in Brazil Ranbaxy, an India-based pharmaceutical firm, has continuing problems with its cholesterol reduction product's price in one of its rapidly growing markets, Brazil. All product is produced in India, with costs and pricing initially stated in Indian rupees (Rps), but converted to Brazilian reais (R$) for distribution and sale in Brazil. In 2009, the unit volume was priced at Rps21,900, with a Brazilian reais price set at R$895. But in 2010, the reais appreciated in value versus the rupee, averaging Rps26.15/R$. In order to preserve the reais price and product profit margin in rupees, what should the new rupee price be set at?

Problem 6 Derek Tosh and Yen-Dollar Parity Derek Tosh is attempting to determine whether US/Japanese financial conditions are at parity. The current spot rate is a flat ¥89.00/$, while the 360-day forward rate is ¥84.90/$. Forecast inflation is 1.100% for Japan, and 5.900% for the US. The 360-day euro-yen deposit rate is 4.700%, and the 360day euro-dollar deposit rate is 9.500%. a. Diagram and calculate whether international parity conditions hold between Japan and the United States. b. Find the forecasted change in the Japanese yes/U.S. dollar (¥/$) exchange rate one year from now.

Problem 7 Sydney to Phoenix Terry Lamoreaux has homes in both Sydney, Australia and Phoenix, United States. He travels between the two cities at least twice a year. Because of his frequent trips he wants to buy some new, high quality luggage. He's done his research and has decided to go with a Briggs & Riley brand three-piece luggage set. There are retails stores in both Phoenix and Sydney. Terry was a finance major and wants to use purchasing power parity to determine if he is paying the same price no matter where he makes his purchase. a. If the price of the 3-piece luggage set in Phoenix is $850 and the price of the same 3-piece set in Sydney is $930, using purchasing power parity, is the price of the luggage truly equal if the spot rate is A$1.0941/$? b. If the price of the luggage remains the same in Phoenix one year from now, determine what the price of the luggage should be in Sydney in one-year time if PPP holds true. The US Inflation rate is 1.15% and the Australian inflation rate is 3.13%.

Problem 8 Corolla Exports and Pass-Through Assume that the export price of a Toyota Corolla from Osaka, Japan is ¥2,150,000. The exchange rate is ¥87.60/$. The forecast rate of inflation in the United States is 2.2% per year and is 0.0% per year in Japan. Use this data to answer the following questions on exchange rate pass through. a. What was the export price for the Corolla at the beginning of the year expressed in U.S. dollars? b. Assuming purchasing power parity holds, what should the exchange rate be at the end of the year? c. Assuming 100% pass-through of exchange rate, what will the dollar price of a Corolla be at the end of the year? d. Assuming 75% pass-through, what will the dollar price of a Corolla be at the end of the year?

Problem 9 Shino Murakami -- CIA Japan (A) Shino Murakami is a foreign exchange trader at Credit Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to invest $5,000,000 or its yen equivalent, in a covered interest arbitrage between U.S. dollars and Japanese yen. He faced the following exchange rate and interest rate quotes. Is CIA profit possible? If so, how? Assumptions Arbitrage funds available Spot rate (¥/$) 180-day forward rate (¥/$) 180-day U.S. dollar interest rate 180-day Japanese yen interest rate

Problem 10 Shino Murakami-- UIA Japan (B) Shino Murakami, Credit Suisse (Tokyo), observes that the ¥/$ spot rate has been holding steady, and both dollar and yen interest rates have remained relatively fixed over the past week. Murakami wonders if he should try an uncovered interest arbitrage (UIA) and thereby save the cost of forward cover. Many of Murakami's research associates -- and their computer models -- are predicting the spot rate to remain close to ¥118.00/$ for the coming 180 days. Using the same data as in the previous problem, analyze the UIA potential.

Problem 11 Kopenhagen Covered (A) Heidi Jensen, a foreign exchange trader at J.P. Morgan Chase, can invest $5 million, or the foreign currency equivalent of the bank's short term funds, in a covered interest arbitrage with Denmark. Using the following quotes can Heidi make covered interest arbitrage (CIA) profit? Assumptions

Value

Arbitrage funds available

$5,000,000

Spot exchange rate (kr/$)

6.1720

3-month forward rate (kr/$) US dollar 3-month interest rate Danish kroner 3-month interest rate

6.1980 3.000% 5.000%

Problem 12 Kopenhagen Covered (B) Heidi Jensen is now evaluating the arbitrage profit potential in the same market after interest rates change. (Note that anytime the difference in interest rates does not exactly equal the forward premium, it must be possible to make CIA profit one way or another.) Assumptions

Value

Arbitrage funds available

$5,000,000

Spot exchange rate (kr/$)

6.1720

3-month forward rate (kr/$) US dollar 3-month interest rate Danish kroner 3-month interest rate

6.1980 4.000% 5.000%

Problem 13 Kopenhagen Covered ( C ) Heidi Jensen is now evaluating the arbitrage profit potential in the same market after interest rates change. (Note that anytime the difference in interest rates does not exactly equal the forward premium, it must be possible to make CIA profit one way or another.) Assumptions

Value

Arbitrage funds available

$5,000,000

Spot exchange rate (kr/$)

6.1720

3-month forward rate (kr/$) US dollar 3-month interest rate Danish kroner 3-month interest rate

6.1980 3.000% 6.000%

Problem 14 Casper Landsten -- CIA (A) Casper Landsten is a foreign exchange trader for a bank in New York. He has $1 million (or its Swiss franc equivalent) for a short term money market investment and wonders if he should invest in U.S. dollars for three months, or make a covered interest arbitrage investment in the Swiss franc. He faces the following quotes: Assumptions

Value

Arbitrage funds available

$1,000,000

Spot exchange rate (SFr./$)

1.2810

3-month forward rate (SFr./$) U.S. dollar 3-month interest rate Swiss franc3-month interest rate

1.2740 4.800% 3.200%

Problem 15 Casper Landsten -- UIA (B) Casper Landsten, using the same values and assumptions as in the previous question, now decides to seek the full 4.800% return available in US dollars by not covering his forward dollar receipts -- an uncovered interest arbitrage (UIA) transaction. Assess this decision.

Problem 16 East Asiatic Company -- Thailand The East Asiatic Company (EAC), a Danish company with subsidiaries all over Asia, has been funding its Bangkok subsidiary primarily with U.S. dollar debt because of the cost and availability of dollar capital as opposed to Thai baht-denominated (B) debt. The treasuer of EAC-Thailand is considering a oneyear bank loan for $250,000. The current spot rate is B32.06/$, and the dollar-based interest is 6.75% for the one year period. One year loans are 12.00% in baht.

a. Assuming expected inflation rates of 4.3% and 1.25% in Thailand and the United States, repectively, for the coming year, according to purchase power parity, what would the effective cost of funds be in Thai baht terms? b. If EAC's foreign exchange advisers believe strongly that the Thai government wants to push the value of the baht down against the dollar by 5% over the coming year (to promote its export competitiveness in dollar markets), what might the effective cost of funds end up being in baht terms? c. If EAC could borrow Thai baht at 13% per annum, would this be cheaper than either part (a) or part (b) above?

Problem 17 Grupo Bimbo (Mexico) Grupo Bimbo, headquartered in Mexico City, is one of the largest bakery companies in the world. On January 1st, when the spot exchange rate is Ps10.80/$, the company borrows $25.0 million from a New York bank for one year at 6.80% interest (Mexican banks had quoted 9.60% for an equivalent loan in pesos). During the year, U.S. inflation is 2% and Mexican inflation is 4%. At the end of the year the firm repays the dollar loan. a. If Bimbo expected the spot rate at the end of one year to be that equal to purchasing power parity, what would be the cost to Bimbo of its dollar loan in peso-denominated interest? b. What is the real interest cost (adjusted for inflation) to Bimbo, in peso-denominated terms, of borrowing the dollars for one year, again assuming purchasing power parity? c. If the actual spot rate at the end of the year turned out to be Ps9.60/$, what was the actual pesodenominated interest cost of the loan?

Problem 18 Bobcat Company Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was Won7,500 million. Won1,000 million has already been paid, and the remaining Won6,500 million is due in six months. The current spot rate is Won1,110/$, and the 6-month forward rate is Won1,175/$. The six-month Korean won interest rate is 16% pe annum, the six-month US dollar rate is 4% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A six-month call option on won with a 1200/$ strike rate has a 3.0% premium, while the six-month put option at the same strike rate has a 2.4% premium. Bobcat can invest at the rates given above, or borrow at 2% per annum above those rates. Bobcat's weighted average cost of capital is 10%. Compare alternate ways that Bobcat might deal with its foreign exchange exposure. What do you recommend and why?

Problem 19 Siam Cement Siam Cement, the Bangkok-based cement manufacturer, suffered enormous losses with the coming of the Asian crisis in 1997. The company had been pursuing a very aggressive growth strategy in the mid1990s, taking on massive quantities of foreign currency denominated debt (primarily U.S. dollars). When the Thai baht (B)was devalued from its pegged rate of B25.0/$ in July 1997, Siam’s interest payments alone were over $900 million on its outstanding dollar debt (with an average interest rate of 8.40% on its U.S. dollar debt at that time). Assuming Siam Cement took out $50 million in debt in June

1997 at 8.40% interest, and had to repay it in one year when the spot exchange rate had stabilized at B42.0/$, what was the foreign exchange loss incurred on the transaction?

Problem 20 P & G India Proctor and Gamble’s affiliate in India, P & G India, procures much of its toiletries product line from a Japanese company. Because of the shortage of working capital in India, payment terms by Indian importers are typically 180 days or longer. P & G India wishes to hedge a 8.5 million Japanese yen payable. Although options are not available on the Indian rupee (Rs), forward rates are available against the yen. Additionally, a common practice in India is for companies like P & G India to work with a currency agent who will, in this case, lock in the current spot exchange rate in exchange for a 4.85% fee. Using the following exchange rate and interest rate data, recommend a hedging strategy. Assumptions

Values

180-day account payable, Japanese yen (¥) Spot rate (¥/ $)

8,500,000

Spot rate, rupees/dollar (Rs/$)

47.75

Implied (calculated) spot rate (¥/Rs)

120.60

2.5257

180-day forward rate (¥/Rs)

2.4000

Expected spot rate in 180 days (¥/Rs)

2.6000

180-day Indian rupee investing rate

8.000%

180-day Japanese yen investing rate

1.500%

Currency agent's exchange rate fee P & G India's cost of capital

4.850% 12.00%

Problem 21 Embraer of Brazil Embraer of Brazil is one of the two leading global manufacturers of regional jets (Bombardier of Canada is the other). Regional jets are smaller than the traditional civilian airliners produced by Airbus and Boeing, seating between 50 and 100 people on average. Embraer has concluded an agreement with a regional U.S. airline to produce and deliver four aircraft one year from now for $80 million. Although Embraer will be paid in U.S. dollars, it also possesses a currency exposure of inputs – it must pay foreign suppliers $20 million for inputs one year from now (but they will be delivering the subcomponents throughout the year). The current spot rate on the Brazilian real (R$) is R$1.8240/$, but it has been steadily appreciating against the U.S. dollar over the past three years. Forward contracts are difficult to acquire and considered expensive. Citibank Brasil has not explicitly provided Embraer a forward rate quote, but has stated that it will probably be pricing a forward off the current 4.00% U.S. dollar eurocurrency rate and the 10.50% Brazilian government deposit note. Advise Embraer on its currency exposure.

Problem 22 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 $1.4200/€ in 90 days. Mattel’s management does not use currency options in currency risk management activities. Advise Mattel on which hedging alternative is probably preferable. Current spot rate ($/€) Credit Suisse 90-day forward rate ($/€)

$1.4158 $1.4172

Barclays 90-day forward rate ($/€)

$1.4195

Mattel Toys WACC ($)

9.600%

90-day eurodollar interest rate

4.000%

90-day euro interest rate

3.885%

90-day eurodollar borrowing rate

5.000%

90-day euro borrowing rate

5.000%

Problem 23 Chronos Time Pieces Chronos Time Pieces of Boston exports wrist watches to many countries, selling in local currencies to watch stores and distributors. Chronos prides itself on being financially conservative. At least 70% of each individual transaction exposure is hedged, mostly in the forward market, but occasionally with options. Chronos's foreign exchange policy is such that the 70% hedge may be increased up to a 120% hedge if devaluation or depreciation appears imminent. Chronos has just shipped to its major North American distributor. It has issued a 90-day invoice to its buyer for €1,560,000. The current spot rate is $1.2224/€, the 90-day forward rate is $1.2270/€. Chronos’s treasurer, Manny Hernandez, has a very good track record in predicting exchange rate movements. He currently believes the euro will weaken against the dollar in the coming 90 to 120 days, possibly to around $1.16/€. a. Evaluate the hedging alternatives for Chronos if Manny is right (Case 1:$1.16/€) and if Manny is wrong (Case 2:$1.26/€). What do you recommend? b. What does it mean to hedge 120% of a transaction exposure? c.What would be considered the most conservative transaction exposure management policy by a firm? How does Chronos compare?...