Chapter 8 Problems Essay

1) In this exercise, you viewed the settlement of costs to finished goods and manufactured output settlement. As noted in the exercise, each should be for $42,000.

b. Joe paid $180 for entertaining a visiting out-of-town client. The client didn’t discuss business with Joe during this visit, but Joe wants to maintain good relations to encourage additional business next year

The current 50% hedging policy executed at the fund level has served well for OTPP for the past ten years, contributing to the fund’s positive returns. The FX Hedge Program not only has minimized the downside risk, but has also limited the upside potential. If OTPP decided not to implement a hedging program in 1996, they would have lost about $983 million CAD over the ten year period (1995-2005) which is valued at 2% of the portfolio. With the hedging program, OTPP was able to reduce the overall loss to about $469 million CAD, but also limited the gain from the depreciation of the pound.(Exhibit 1) Hedging is an excellent short-term risk minimizing strategy for long term investors, sustaining a continual payout of pensions during volatile times in OTPP’s invested currency markets. Currently, approximately 21% of OTPP’s net assets are exposed to foreign currency risk. Consequently, it is essential that OTPP maintain a risk management program of hedging, as slight currency fluctuations can significantly affect the value of the fund. Similarly to continual renewal of swaps, hedging can be a very expensive risk management strategy.

Had Dozier’s management considered hedging their currency exposure on December 3, 1985, the day the bid was submitted, they would have been able to enter into the following contracts:

The black market rate of Rp 50.00/U.S.$ represented a devaluation from the current rate of Rp40.4795/$ of about 23.5%.

i) Given that Dozier industries does nothing to hedge this risk, assuming that spot exchange rate remains the same as on Jan 14,1986 levels,

In order to reduce risk, the company is using two hedging derivatives: forward contracts and put options to sell dollars. The aim of the paper is to determine an appropriate hedging policy which answers two main questions: how much to hedge, and in what proportions of forwards

Practicing CIA (Covered Interest Arbitrage) by borrowing CAD 96 Million to buy USD on April 1, 2002, and invest the USD for six months. At CAD interest rates of 2.70% for borrowing and 2.55% for depositing, and USD interest rates of 1.85% for borrowing and 1.65% for depositing.

The buyer will accept the Goods and pay for the Goods with the sum of sixty thousand (16,000.00) USD, paid in cash as required in clause 4 of this Agreement.

Current Strategy. The company has been hedging the US dollar long position by estimating its annual US dollar sales and hedging that exposure by purchasing put options on the US dollar (the right to sell US dollars for euros at a specific exchange rate). The company has been purchasing these options in what it refers to as a “three-year rolling hedge” in which it hedges expected US dollar sales three years out

B. Suppose an American exporter has just received a payment of € 100,000, how many dollars will result upon conversion?

1. How profitable is the original sale to Novo once the exchange-rate changes are acknowledged? How has the exchange-rate risk, which affected the value of the order, been managed?

2) Minimize the cost associated with the foreign exchange risk management strategy, i.e. the management and hedging costs

Based on your answer to question 2, how would Mesa’s cash flows be affected by the expected exchange rate movements? Explain.

Hedging is a significant measure of financial risk management. Since the 1970s, the increasing number of powerful companies started to control the risk of the exchange rate, the interest rate and commodity by using financial derivatives. ISDA (2013) based on the Global 500 Annual Report 2012 survey found that 88 percent of companies use foreign exchange derivatives. Modigliani & Miller (1958) believed that if the financial markets were under perfect conditions, for instance, there was no agency costs, asymmetric information, taxes and transaction costs, hedging would not increase the company 's value because investors can hedge by themselves. However, a large number of practical studies have shown that hedging is beneficial