International Financial Management
14th Edition
ISBN: 9780357130698
Author: Madura
Publisher: Cengage
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Palmetto Bug Extermination Corporation (PBEC), a U.S. company, regularly purchases chemicals from a supplier in Switzerland with the invoice price denominated in Swiss francs. PBEC has experienced several foreign exchange losses in the past year due to increases in the U.S. dollar price of the Swiss currency. As a result, Dewey Nukem, PBEC's CEO, has asked you to investigate the possibility of using derivative financial instruments, specifically foreign currency forward contracts and foreign currency options, to hedge the company's exposure to foreign exchange risk.
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Draft a memo to CEO Nukem comparing the advantages and disadvantages of using forward contracts and options to hedge foreign exchange risk. Recommend the type of hedging instrument you believe the company should employ and justify this recommendation.
Ahnuld Corporation, a health juice producer, recently expanded its sales through exports to foreign markets. Earlier this year, the company negotiated the sale of several thousand cases of turnip juice to a retailer in the country of Tcheckia. The customer is unwilling to assume the risk of having to pay in U.S. dollars. Desperate to enter the Tcheckian market, the vice president for international sales agrees to denominate the sale in tchecks, the national currency of Tcheckia. The current exchange rate for 1 tcheck is $2.00. In addition, the customer indicates that it cannot pay until it sells all of the juice. Payment of 100,000 tchecks is scheduled for six months from the date of sale.Fearful that the tcheck might depreciate in value over the next six months, the head of the risk management department at Ahnuld Corporation enters into a forward contract to sell tchecks in six months at a forward rate of $1.80. The forward contract is designated as a fair value hedge of the tcheck…
Magna Steel Erectors, a Canadian manufacturer and exporter of steel components in bridge building has negotiated a deal with BridgeCon Inc., an American bridge construction firm. They have been doing business for several years and have used both Open Account and Letters of Credit. Recently BridgeCon has experienced some challenges in paying on time and maintaining its creditworthiness. Rumours are rampant about the potential for BridgeCon to encounter severe financial difficulty. As a result, Magna is worried about being paid for future shipments. In addition, Magna has recently lost several key engineers and project managers which has severely impacted their ability to perform key work and complete some recent projects on time and to the satisfaction of previous customers. Name and describe two types of Standby Letters of Credit that could address the concerns that Magna has about BridgeCon or that BridgeCon might have about Magna
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- If a U.S.-based company regularly purchases goods from foreign suppliers in Japan with the invoice price denominated in Japanese Yen. And if the U.S. company has experienced several foreign exchange losses due to the appreciation of the Japanese Yen. I am confused about which type of hedging instrument (Foreign currency forward contract or foreign currency option) the company should employ. Can you please help me to understand a justification for the selection? Maybe to illustrate, you can compare the advantages and disadvantages of using (Forward contracts) and (Options) to hedge foreign exchange risk.arrow_forwardSuppose a U.S. firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies, and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following? Interest rate disparities Short-run exposure to exchange rate risk Long-run exposure to exchange rate risk Political risk associated with the foreign operations Translation exposure to exchange rate riskarrow_forwardHull Importing Company is a U.S.-based firm that imports small gift items and sells them to retail gift shops across the United States. About half of the value of Hull’s purchases comes from the United Kingdom, while the remaining purchases are from Mexico. The imported goods are denominated in the currency of the country where they are produced. Hull normally does not hedge its purchases. In previous years, the Mexican peso and pound fluctuated substantially against the dollar (although not by the same degree). Hull’s expenses are directly tied to these currency values because all of its products are imported. It has been successful because the imported gift items are somewhat unique and are attractive to U.S. consumers. However, Hull has been unable to pass on higher costs (due to a weaker dollar) to its consumers, because consumers would then switch to different gift items sold at other stores.arrow_forward
- ABC Ltd. ABC Ltd.’s principal business activity is the assembly of circuit boards. One of the key materials used is copper wiring, all of which is imported. As a cost cutting measure, a contract with a new overseas supplier was signed, and all of the company’s copper wiring is now supplied under this contract. Purchases are denominated in a foreign currency, but the company does not use forward exchange contracts in relation to its imports of copper wiring. The company has two production facilities, one of which produces goods for the export market, and the other produces goods for the domestic market. About half of its goods are exported, but the export market is suffering due to competition from cheaper producers overseas. Most domestic sales are made under contract with approximately 20 customers. In October 2020, production was halted for a week at the production facility which supplies the domestic market. A number of customers had returned goods, claiming faults in the circuit…arrow_forwardTaft Corporation operates primarily in the United States. However, a few years ago it opened a plant in Spain to produce merchandise to sell there. This foreign operation has been so successful that during the past 24 months the company started a manufacturing plant in Italy and another in Greece. Financial information for each of these facilities follows:The company’s domestic (U.S.) operations reported the following information for the current year:Taft has adopted the following criteria for determining the materiality of an individual foreign country: (1) Sales to unaffiliated customers within a country are 10 percent or more of consolidated sales or (2) long-lived assets within a country are 10 percent or more of consolidated long-lived assets.Apply Taft’s materiality tests to identify the countries to report separately with respect to (a) revenues and (b) long-lived assets.arrow_forwardIf Blades does not enter into the agreement with the British firm and continues to export to Thailand and import from Thailand and Japan, do you think the increased correlations between the Japanese yen and the Thai baht will increase or decrease Blades’ transaction exposure?arrow_forward
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