FOREIGN EXCHANGE MARKET AND TRADE – SMF 4053

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FOREIGN
EXCHANGE MARKET AND TRADE – SMF 4053

Tutorial
5

1.
In December 2005, two
parties A & B, agreed on a five-year currency swap whereby A received
payments in AUD and B received payments in Canadian Dollar (CAD) at a
contracted exchange rate of 0.9181 (AUD/CAD). The notional principal of the
swap is CAD500,000. The exchange rate assumed the following values on the
payment dates:

Payment Date Exchange
Rate
Dec 2005 1.0751
Dec 2006 1.0672
Dec 2007 1.0555
Dec 2008 1.1942
Dec 2009 1.2890

Calculate the payments (in AUD terms) received by A and B on each payment
date. Calculate also net payments.

2.
In December 2005, two
parties A & B, agreed on a five-year fixed-for-floating Australian dollar
swap, whereby A received payments based on floating interest rate and B
received payments in fixed interest rate. The notional principal of the swap is
AUD 500,000 and fixed rate is 4.95%. The floating interest rate assumed the
following values on the payment dates:

Payment Date Exchange
Rate
Dec 2005 4.62%
Dec 2006 5.08%
Dec 2007 6.03%
Dec 2008 5.95%
Dec 2009 5.70%

Calculate the payments (in AUD terms) receivedby A and B on each payment date. Calculate
also the net payments.

3

Trident Corporation entered into a three-year cross currency interest
rate swap to receive U.S. dollars and pay Swiss francs. Trident, however,
decided to unwind the swap after one year – thereby having two years left on
the settlement costs of unwinding the swap after one year. Repeat the
calculations for unwinding, but assume that the following rates now apply:

Assumptions

Values

Swap Rates

3- year bid

3-year ask

Notional principal

$10,000,000

Original: US dollar

5.56%

5.59%

Original spot exchange rate, SFr./$

1.5000

Original: Swiss franc

1.93%

2.01%

New (1-year later) spot exchange rate, SFr./$

1.5560

New fixed US dollar interest

5.20%

New fixed Swiss franc interest

2.20%

4

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 mid-1990s, 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?

5

Vizor
Pharmaceuticals, a U.S.-based multinational pharmaceutical company, is
evaluating an export sale of its cholesterol-reduction drug with a
prospective Indonesian distributor. The purchase would be for 1,650 million
Indonesian rupiah (Rp), which at the current spot exchange rate of Rp9,450/$,
translates into nearly $175,000. Although not a big sale by company
standards, company policy dictates that sales must be settled for at least a
minimum gross margin, in this case, a cash settlement of $168,000. The
current 90-day forward rate is Rp9,950/$. Although this rate appeared
unattractive, Vizor had to contact several major banks before even finding a
forward quote on the rupiah. The consensus of currency forecasters at the
moment, however, is that the rupiah will hold relatively steady, possibly
falling to Rp9,400/$ over the coming 90 to 120 days. Analyze the prospective
sale and make a hedging recommendation.

6

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 ($/€)

$1.4158

Credit Suisse
90-day forward rate ($/€)

$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%

7

Pupule Travel, a
Honolulu, Hawaii – based 100% privately owned travel company has signed an
agreement to acquire a 50% ownership share of Taichung Travel, a Taiwan – based
privately owned travel agency specializing in servicing inbound customers
from the United States and Canada. The acquisition price is 7 million Taiwan
dollars (T$ 7,000,000) payable in cash in 3 months.

Thomas Carson,
Pupule Travel’s owner, believes the Taiwan dollar will either remain stable
or decline a little over the next 3 months. At the present spot rate of
T$35/$, the amount of cash required is only $200,000 but even this relatively
modest amount will need to be borrowed personally by Thomas Carson. Taiwanese
interest-bearing deposits by non-residents are regulated by the government,
and are currently set at 1.5% per year. He has a credit line with Bank of
Hawaii for $200,000 with a current borrowing interest rate of 8% per year. He
does not believe that he can calculate a credible weighted average cost of
capital since he has no stock outstanding and his competitors are all also
privately-owned without disclosure of their financial results. Since the
acquisition would use up all his available credit, he wonders if he should
hedge this transaction exposure. He has quotes from Bank of Hawaii shown in
the table below.

Spot rate (T$/$)

33.40

3-month forward
rate (T$/$)

32.40

3-month Taiwan
dollar deposit rate

1.500%

3-month dollar
borrowing rate

6.500%

3-month call
option on T$

not available

Analyze the
costs and risks of each alternative, and then make a recommendation as to
which alternative Thomas Carson should choose.

8

Lucky 13 Jeans
of San Antonio, Texas, is completing a new assembly plant near Guatemala
City. A final construction payment of Q8,400,000 is due in six months. (“Q”
is the symbol for Guatemalan quetzals.) Lucky 13 uses 20% per annum as its
weighted average cost of capital. Today’s foreign exchange and interest rate
quotations are:

Construction
payment due in six-months (A/P, quetzals)

8,400,000

Present spot
rate (quetzals/$)

7.0000

Six-month
forward rate (quetzals/$)

7.1000

Guatemalan
six-month interest rate (per annum)

14.000%

U.S. dollar
six-month interest rate (per annum)

6.000%

Lucky 13’s
weighted average cost of capital (WACC)

20.000%

Lucky 13’s
treasury manager, concerned about the Guatemalan economy, wonders if Lucky 13
should be hedging its foreign exchange risk. The manager’s own forecast is as
follows:

Expected spot
rate in six-months (quetzals/$):

Highest expected rate (reflecting a
significant devaluation)

8.0000

Expected rate

7.3000

Lowest expected rate (reflecting a
strengthening of the quetzal)

6.4000

What realistic
alternatives are available to Lucky 13 for making payments? Which method
would you select and why?

9

Micca Metals,
Inc. is a specialty materials and metals company located in Detroit,
Michigan. The company specializes in specific precious metals and materials
which are used in a variety of pigment applications in many other industries
including cosmetics, appliances, and a variety of high tinsel metal
fabricating equipment. Micca just purchased a shipment of phosphates from
Morocco for 6,000,000, dirhams, payable in six months.

Six-month call
options on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar
are available from Bank Al-Maghrub at a premium of 2%. Six-month put options
on 6,000,000 dirhams at an exercise price of 10.00 dirhams per dollar are
available at a premium of 3%. Compare and contrast alternative ways that
Micca might hedge its foreign exchange transaction exposure. What is your
recommendation?

Assumptions

Values

Shipment of
phosphates from Morocco, Moroccan dirhams

6,000,000

Micca’s cost of
capital (WACC)

14.000%

Spot exchange
rate, dirhams/$

10.00

Six-month
forward rate, dirhams/$

10.40

10

Trident — the
same U.S.-based company as discussed in this chapter, has concluded a second
larger sale of telecommunications equipment to Regency (U.K.). Total payment
of £3,000,000 is due in 90 days. Maria Gonzalez has also learned that Trident
will only be able to borrow in the United Kingdom at 14% per annum (due to
credit concerns of the British banks). Given the following exchange rates and
interest rates, what transaction exposure hedge is now in Trident’s best
interest?

Assumptions

Value

90-day A/R in
pounds

£3,000,000.00

Spot rate, US$
per pound ($/£)

$1.7620

90-day forward
rate, US$ per pound ($/£)

$1.7550

3-month U.S.
dollar investment rate

6.000%

3-month U.S.
dollar borrowing rate

,
,
,
,
8.000%,
,
,
,
,
,
,
,
,
,
,
,
,
,
,
3-month UK,
investment interest rate,
,
,
,
,
,
8.000%,
,
,
,
,
,
,
,
,
,
,
,
,
,
,
3-month UK
borrowing interest rate

14.000%

Put options on
the British pound: Strike rates, US$/pound ($/£)

Strike rate ($/£)

$1.75

Put option premium

1.500%

Strike rate ($/£)

$1.71

Put option premium

1.000%

Trident’s WACC

12.000%

Maria Gonzalez’s
expected spot rate in 90-days, US$ per pound ($/£)

$1.7850