Case #37
Baker Adhesives Synopsis and Objectives
Baker Adhesives (Baker) has just made its first foray into international sales and must come to grips with the impact of exchange-rate changes on the profitability of a past order. The company must also formulate a strategy for dealing with exchange-rate risks for future orders. The case is intended as an introduction to exchange-rate risk and the management of that risk. Upon receipt of payment from a past order, the firm realizes that exchange-rate movements have reduced the value of the sale. A follow-on order provides the context for exploring possible mechanisms for managing that risk. In particular, sufficient direction and information is provided to examine both a forward
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Typical possibilities include:
* asking Novo to pay in dollars; * increasing the price to cover the risk; * choosing forward hedges or money-market hedges; * using other currency contracts such as options.
The first is the most obvious, but not as easy as one might think. This is a matter for negotiation, especially in contexts without standardized contracts, but Baker is not in a particularly good bargaining position. It is a small company; it needs the work.
The second point is usually suggested in a number of ways. We should understand there is a risk-and-return trade-off and therefore conclude one can price the risk into the contract.
The forward and money-market hedges are discussed in detail below. At this point, it is sufficient to acknowledge that these financial contracts do mitigate the risk. Other suggested contracts are beyond the scope of this case, but should be acknowledged.
Hedging
Before exploring the two hedges, it is useful to ask what the present value of the expected cash flow would be if Baker remains unhedged. One may question the need to calculate a present value. The cash flow obtained from a money-market hedge and that cash flow will be a current cash flow. Thus, one will either have to calculate present values or future values to make comparisons—and the present value is more naturally interpreted.
Owens & Minor is a distributor of surgical and medical supplies to hospitals and other health care facilities. Due to changing demand from customers, the company is facing increased operating costs, which has resulted in lower profit margins and even losses. In 1993, O&M recorded an $18 million profit, which was reduced to a loss of $11 million in 1995. The entire industry is experiencing similar difficulties. In an effort to resume profitability, O&M is evaluating alternatives to “cost-plus pricing”. Cost-plus pricing does not reflect the true cost of the services provided by O&M. Customers are demanding more of O&M while
Sparkle Company is a Nigerian diamond mining company. Sparkle is a joint venture, 50 percent owned by Shine and 50 percent owned by Brighten. Both Shine and Brighten are U.S.-based companies with their functional currency being the American dollar. Sparkle Companies functional currency is that of Nigeria, being the Naira. During 2009, Sparkle had several transactions with its joint venture owners and outside parties. The details of Sparkle’s transactions are three loans, three expenditures, and one revenue stream. The loans the company took out were $1 million from Brighten, $1 million from Shine, and 300 million Naira from a local Nigerian bank. The expenditures
ASC 320-10-35-33F: “Changes in the quality of the credit enhancement should be considered when estimating whether a credit loss exists and the period over which the debt security is expected to recover.”
3. Seeing that the dispute involved the sale of land, specific performance is the proper award for damages to the injured party.
The derivatives program was reducing risk when the firm was investing in foreign currency futures for the first four months from the implementation date (February 1991 to May 1991). This is seen by the negative correlation of (0.94226594) between the derivative (futures) cash flow and the unhedged cash flow. A purpose of a perfect hedge is to obtain a net of zero or in other words, reduce your risk to nothing not including the cost of the hedge. If a correlation is negative, as it was for the first three
Financial hedging is the use of hedging instruments - typically FX forwards, options and swaps - that are sold by foreign exchange brokers and banks to reduce company exposure to currency fluctuations. (Export Development Canada, 2016) Acknowledging that foreign exchange risk is a real threat to corporate cash flows, assets and expenses can be one of the biggest hurdles for most companies. However, recognizing the importance of protecting assets companies can move forward in identifying the type and magnitude of the risk to implement strategies to mitigate them. The three most common types of foreign exchange risks are:
Build the management-research question hierarchy, through the investigative questions stage. Then compare your list with the measurement questions asked.
Young Professional magazine was developed for a target audience of recent college graduates who are in their first 10 years in a business/professional career. In its two years of publication the magazine has been fairly successful. Now the publisher is interested in expanding the magazine’s advertising base. Potential advertisers continually ask about the demographics and interests of subscribers to Young Professional. To collect this information the magazine has commissioned a survey to develop a profile of its subscribers. The survey results will be used to help the magazine choose articles of interest and provide advertisers with a profile of subscribers. As a new employee of the magazine, you have been
Jules Kroll is planning to enter into the ratings industry. To determine whether it is a good idea and a good time for him to enter into the new business, we project the 5-year NPV for KBRA and apply SWOT analysis to KBRA. The 5-year projected NPV is $341.1 million, a positive number. It is a good time and a good idea for KBRA to enter the business. However, through our SWOT analysis, it would be difficult for KBRA to become competitive in a short time. Thus we suggest it add a credit rating division into the company to make attempts to it but not start up a
Given the nature of its business, Jaguar is faced with three types of exchange rate exposure (1) Transaction, (2) Translation and (3) Economic . Transaction exposures arise whenever the firm commits (or is contractually obligated) to make or receive a payment at a future date denominated in a foreign currency. Translation exposures arise from accounting based changes in consolidated financial statements caused by a change in exchange rates. In this case we primarily focus on the Economic exposure -also known as Operating exposure or Competitive exposure- of Jaguar.
Assume that one of Philip’s clients is a married man, aged 36 with two young children, who wishes to reallocate a significant portion of his retirement funds that are currently invested in certificates of deposit. Philip recommends a growth investment, and he identifies the three representative possibilities shown in Table A.
However, with the passage of time, people’s understanding of the role of financial derivatives gradually deepening, hedge funds in recent years, favoured because hedge funds have the ability to make money in the bear market. From 1990 to 2002, ordinary public funds lost an average of 11.7 per cent a year, while hedge funds earned 11.2 per cent a year during the same periods. There are some reasons for hedge funds which got such impressive results in surveys, and the benefits they receive are not as easy as the outside, and almost all hedge fund managers are excellent financial brokers.
There are many different types of derivative instruments that can be used in financial markets. This paper will examine the various different types of futures contracts, (futures) that are available to be purchased in the marketplace. It will be shown what role they play in managing risk with multinational companies, portfolio managers, and institutional investors alike. It will also be touched on about how speculators can find opportunities for financial gain with the use of futures.
ic: Show how transactions in derivative instruments can be used to either hedge risks or to open speculative positions.
Evidence from studies suggest that firms involved in foreign operations are exposed to foreign exchange risks which can be further classified into the economic exposure, the transactional exposure and the translational exposure (Moyer et al. 2011; Lumby 2001). Arnold (2008) observed that investment decisions and the viability of foreign operations in the long term are affected by both the transaction, translation and economic risks. This is so because entities are affected by variability of