Problem 10.

1 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 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/US$ in July 1997, Siam’s interest payments
alone were over US$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 US$50 million in debt in June 1997 at
8.40% interest, and had to repay it in one year when the spot exchange rate had stabilised at B42.0/US$,
what was the foreign exchange loss incurred on the transaction?

Assumptions Value
US dollar debt taken out in June 1997 USD 50,000,000
USD borrowing rate on debt 8.400%
Initial spot exchange rate, baht/USD, June 1997 25.00
Average spot exchange rate, baht/USD, June 1998 42.00

Calculation of Foreign Exhange Loss on Repayment of Loan

At the time the loan was acquired, the scheduled repayment of USD
and baht amounts would have been as follows:

Scheduled Repayment:
Repayment of US dollar debt: Principal USD 50,000,000
Repayment of US dollar debt: Interest 4,200,000
Total repayment USD 54,200,000

Exchange rate at time of repayment, baht/USD 25.00

Total repayment in Thai baht (54,200,000 x 25) 1,355,000,000
Total proceeds from loan, up-front, in Thai baht (50,000,000 x 25) 1,250,000,000
Net interest to be paid, in Thai baht 105,000,000

Actual Repayment:
Repayment of US dollar debt: Principal USD 50,000,000
Repayment of US dollar debt: Interest (USD 50 m x 8.4%) 4,200,000
Total repayment USD 54,200,000

Exchange rate at time of repayment, baht/USD 42.00

Total repayment in Thai baht (54,200,000 x 42) 2,276,400,000
Less what Siam had EXPECTED or SCHEDULED to be repaid (1,355,000,000)
Amount of foreign exchange loss on debt 921,400,000

This study source was downloaded by 100000841150731 from CourseHero.com on 03-13-2022 05:05:34 GMT -05:00

https://www.coursehero.com/file/13917309/Tutorial-6-Solutions-Chap10-3A14/
 Problem 10.5 Commander Communications

Commander Communications is an Australian Communication equipment manufacturing company based in Melbourne.

In September Commander delivers a large shipment of equipment to a major distributor in Canada. The receivable, C$30
million, is due in 90 days. Commander's treasury team has collected the following currency and market quotes. The
company’s foreign exchange advisors believe the CAD will be at about A$1.1800/C$ in 90 days. Commander’s management
does not use currency options in currency risk management activities. Advise Commander on which hedging alternative is
probably preferable.

Current spot rate (A$/C$) A$1.2186/CAD

90-day Canadian interest rate 4.40%
90-day forward quote (A$/C$) A$1.2170/CAD
Macqarie Bank bid 90-day Australian interest rate 4.00%
Macquarie Bank ask 90-day forward quote (A$/C$) A$1.2210/CAD
90-day Australian dollar borrowing rate 5.000%
Commander's cost of capital 9.600%
90-day Canadian dollar borrowing rate 5.500%

Given information and working: Values

90-day A/R (C$) CAD 30,000,000.00
Current spot rate (A$/C$) AUD 1.2186
Bid 90-day forward quote (A$/C$) AUD 1.2170
Ask 90-day forward quote (A$/C$) AUD 1.2210
Expected spot rate in 90 days (A$/C$) AUD 1.1800
90-day Australian interest rate 4.000%
90-day Canadian interest rate 4.400%
Implied 90-day forward rate (calculated, A$/C$) AUD 1.2174
90-day Australian dollar borrowing rate 5.000%
90-day Canadian dollar borrowing rate 5.500%
Commander's cost of capital 9.600%

Risk
Hedging Alternatives Values Assessment
1. Remain Uncovered, settling A/R in 90 days at market rate
Company will sell Canadian dollars in 90 days as it will receive Canadian dollars after 90 days.

(30 million Canadian dollars / future spot rate)

If spot rate in 90 days is same as current (30,000,000 x 1.2186) AUD 36,558,000.00 Risky

If spot rate in 90 days is same as 90-day bid forward rate (30,000,000

x 1.2170) AUD 36,510,000.00 Risky

If spot rate in 90 days is same as ask 90-day forward rate (30,000,000

x 1.2210) AUD 36,630,000.00 Risky

If spot rate in 90 days is expected spot rate (30,000,000 x 1.18) AUD 35,400,000.00 Risky

2. Sell Canadian dollars forward 90 days because the company can sell Canadian dollars after it receives it in 90 days

Settlement amount at 90 day forward rate (30,000,000 x 1.2170) AUD 36,510,000.00 Certain

3. Money Market Hedge

The company borrows Canadian dollars because it can ensure that the Canadian dollars it will receive can be used
to repay the Canadian dollar loan
Principal A/R in Canadian CAD 30,000,000.00
discount factor for Canadian borrowing rate for 90 days 0.9864 1/(1 + (.055 x 90/360))
Borrow Canadian against 90-day A/R [30mio x 0.9864) CAD 29,593,094.94

Current spot rate, A$/C$ AUD 1.2186

Australian dollar current value AUD 36,062,145.50 =D55*D57
Commander's carry-forward factor for 90 days 1.0240 1 + (.0960 x 90/360)
A$ need to be carried forward for comparison
Future value of money market hedge [36,062,145.50 x 1.0240] AUD 36,927,636.99 Certain

Evaluation of Alternatives

The money market hedge guarantees Commander the greatest dollar value for the A/R when using the cost of capital as the
reinvestment rate (carry-forward rate).

This study source was downloaded by 100000841150731 from CourseHero.com on 03-13-2022 05:05:34 GMT -05:00

https://www.coursehero.com/file/13917309/Tutorial-6-Solutions-Chap10-3A14/
 Problem 10.7 Multiplex

Multiplex of Perth, Western Australia, is completing a new assembly plant in Hong Kong. A final construction payment of
HKD8,400,000 is due in six months. Multiplex 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) HK$8,400,000

Present spot rate (HKD/A$) 7.0000
Six-month forward rate (HKD/A$) 7.1000
Hong Kong six-month interest rate (per annum) 14.000%
Australian dollar six-month interest rate (per annum) 6.000%
Multiplex weighted average cost of capital (WACC) 20.000%

Multiplex's treasury manager, concerned about the Hong Kong economy, wonders whether Multiplex should be hedging its
foreign exchange risk. The manager’s own forecast is as follows:

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

Highest expected rate 8.0000
Expected rate 7.3000
Lowest expected rate 6.4000

What realistic alternatives are available to Multiplex for making payment? Which method would you select and why?

a) What realistic alternatives are available to Multiplex? Cost Certainty

1. Wait six months and make payment at spot rate

Purchase HK$ in six months as company needs to pay after 6 months
Highest expected rate (8,400,000 / 8.0) A$ 1,050,000.00 Risky

Expected rate (8,400,000 / 7.3) A$ 1,150,684.93 Risky

Lowest expected rate (8,400,000 / 6.4) A$ 1,312,500.00 Risky

2. Purchase HKD forward six-months A$ 1,183,098.59 Certain

because the company needs to pay HK$ after 6 months
(A/P divided by the forward rate = 8,400,000 / 7.1)
There is no cash flow now.
In 6 mths the contract is fufilled by delivering A$1,183,098.59 for receipt of HKD 8.4 million.
Then, pay the HKD 8.4 million payable.

3. Borrow A$ and convert to HKD today, invest for six-months

The company invest in HKD today so that when the investment matures, it will be able to pay HKD 8.4 million
HKD needed today (A/P discounted 180 days =
8,400,000 / [1+14%x(180/360)] HK$7,850,467
Cost in A$ today (HKD to A$ at spot rate = 7,850,467 / 7.0) A$ 1,121,495.33
factor to carry dollars forward 180 days (1 + (WACC/2)) 1.10
Cost in dollars in six-months (A$ carried forward 180 days ) A$ 1,233,644.86 Certain
[1,121,495.33 x 1.10]
A$ need to be carried forward for comparison

The second choice, the forward contract, results in the lowest cost alternative among certain alternatives.

This study source was downloaded by 100000841150731 from CourseHero.com on 03-13-2022 05:05:34 GMT -05:00

https://www.coursehero.com/file/13917309/Tutorial-6-Solutions-Chap10-3A14/
 Problem 10.11 Micca Metals, Inc.

Micca Metals Inc. is a specialty materials and metals company located in Detroit, Michigan. The company specialises 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-tensile metal fabricating equipment. Micca just purchased a
shipment of phosphates from Morocco for 6,000,000 dirhams, payable in six months. Micca’s cost of capital is 8.600%.
The following quotes are available in the market:

United States Morocco

Six-month interest rate for borrowing (per annum) 6.000% 8.000%
Six-month interest rate for investing (per annum) 5.000% 7.000%
Spot exchange rate, dirhams/US$ 10.00
Six-month forward rate, dirhams/US$ 10.40

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?

Given information: Values

Shipment of phosphates from Morocco, Moroccan dirhams 6,000,000 Dirhams
Micca's cost of capital (WACC) 8.600%
Spot exchange rate, dirhams/US$ 10.00
Six-month forward rate, dirhams/US$ 10.40

Options on Moroccan dirhams: Call Option Put Option

Strike price, dirhams/US$ 10.00 10.00
Option premium (percent) 2.000% 3.000%

United States Morocco

Six-month interest rate for borrowing (per annum) 6.000% 8.000%
Six-month interest rate for investing (per annum) 5.000% 7.000%

Risk Management Alternatives Values Certainty

1. Remain uncovered, making the dirham payment in six months

at the spot rate in effect at that date
Account payable (dirhams) 6,000,000 Dirhams
Possible spot rate in six months - the current spot rate (dirhams/US$) 10.00
Cost of settlement in six months (US$)[= 6,000,000 / 10] USD 600,000 Uncertain.

Account payable (dirhams) 6,000,000

Possible spot rate in six months - forward rate (dirhams/US$) 10.40
Cost of settlement in six months (US$) [=6,000,000 / 10.4] USD 576,923 Uncertain.

2. Forward market hedge. Buy dirhams forward six months.

Account payable (dirhams) 6,000,000 Dirhams

Six month forward rate, dirhams/$ 10.40
Cost of settlement in six months (US$) [6,000,000 / 10.4] USD 576,923 Certain.

3. Money market hedge. Exchange dollars for dirhams now, invest for six months.

Account payable (dirhams) 6,000,000.00

Discount factor at the dirham investing rate for 6 months (=1+ 7%/2) 1.035
Dirhams needed now for investing (payable/discount factor) 5,797,101.45
Current spot rate (dirhams/US$) 10.00
US dollars needed now USD 579,710
Carry forward rate for six months (= 1+WACC/2) 1.043
US dollar cost, in six months, of settlement USD 604,638 Certain.

4. Call option hedge.

Buy call on dirhams as need to pay dirhams in the future
Option principal 6,000,000.00
Current spot rate, dirhams/US$ 10.00
Premium cost of option 2.000%
Option premium (principal/spot rate x % premium) USD 12,000

If option exercised, dollar cost at strike price of 10.00 dirhams/US$ USD 600,000
Plus premium carried forward six months (prem x 1.043) USD 12,516
Total net cost of call option hedge if exercised USD 612,516 Maximum.

The lowest cost certain alternative is the forward. If Micca were to expect the dirham to depreciate significantly over the next six
months, it may choose the call option.

This study source was downloaded by 100000841150731 from CourseHero.com on 03-13-2022 05:05:34 GMT -05:00

https://www.coursehero.com/file/13917309/Tutorial-6-Solutions-Chap10-3A14/
 Problem 10.13 Susan Martin and Belmont (A)

Belmont, the same Australian resource company discussed throughout this chapter, has concluded a second larger sale of iron
ore to Regency (Germany). Total payment of €3,000,000 is due in 90 days. Susan Martin has also learned that Belmont will only
be able to borrow in Germany at 12% per annum (due to credit concerns of the German banks). Given the following exchange
rates and interest rates, what transaction exposure hedge is now in Belmont’s best interest?

Spot rate A$1.6800/€

Expected spot rate in 90-days A$1.6950/€
90-day forward rate A$1.6733/€
90-day Australian deposit rate 4.0% per annum
90-day Australian borrowing rate 6.0% per annum
90-day Euro deposit rate 6.0% per annum
90-day Euro borrowing rate 12.0% per annum
Belmont's WACC 10.0% per annum

Susan has also collected data on two specific options as well:

Put options on the Euro: Strike rates A$1.68/€ A$1.64/€
Put option premium 1.5% 1.0%

Given information: Value Value (B)

90-day A/R in euros € 3,000,000.00
Spot rate, A$ per euro (A$/€) A$1.6800
90-day forward rate, A$ per euro (A$/€) A$1.6733
90-day Australian deposit rate 4.000%
90-day Australian borrowing rate 6.000%
90-day Euro deposit rate 6.000%
90-day Euro borrowing rate 12.000%
Put options on the Euro: Strike rates, A$/€) A$1.6800 A$1.6400
Put option premium 1.500% 1.000%
Belmont's WACC 10.000%
Expected spot rate in 90-days, A$ per euro (A$/€) A$1.6950

Alternative #1: Remain Uncovered Rate (A$/€) Proceeds

The company will sell euros in 90 days as it will receive euros after 90 days
Value of A/R will be (3 million euros x ending spot rate (A$/€))
If spot rate is the same as current spot rate A$1.6800 A$5,040,000.00
If ending spot rate is the same as current forward rate A$1.6733 A$5,019,900.00
If ending spot rate is the expected spot rate A$1.6950 A$5,085,000.00

Alternative #2: Forward Contract Hedge Rate (A$/€) Proceeds

The company can sell euros after it receives it in 90 days
Sell the euros forward 3-months locking in the forward rate
Euro A/R at the forward rate (euro x forward) $1.6733 A$5,019,900.00

Alternative #3: Money Market Hedge Rate (A$/€) Proceeds

The company borrows euros because it can ensure that the euros it will receive can be used
to repay the euro loan
Borrows against the A/R, receiving € up-front, exchanging into A$.
Amount of A/R in 90-days, in euros € 3,000,000.00
Discount factor, euro borrowing rate, for 3-months ([1+12%x(90/360)] 0.9709
Proceeds of borrowing, up-front, in euros (3,000,000 x 0.9709) € 2,912,621.36
Exchanged to A$ at current spot rate of A$1.6800
A$ received against A/R, up-front (2,912,621.36 x 1.68) A$4,893,203.88
A$ needed to be carried forward for comparison:
Carry-forward rate, WACC for 90-days (= 1+10%/4) 1.0250
Money Market Hedge, A$, at end of 90-days (4,893,203.88 x 1.025) A$5,015,533.98

Strike Rate (A$/€) Strike Rate (A$/€)

Alternative #4: Put Option Hedges 1.68 1.64
The company purchases put option on euros because the put option enables the holder to sell euros on maturity
on which the co will receive the same amount of Euros.
Option premium 1.500% 1.000%
Notional principal of option (euros) € 3,000,000.00 € 3,000,000.00
Spot rate (A$/euros) $1.6800 $1.6800
Option premium, A$ (%prem x 3,000,000 x 1.68) A$75,600.00 A$50,400.00
Carry-forward factor, WACC, for 90-days 1.0250 1.0250
Total premium cost, in 90-days A$77,490.00 A$51,660.00

Proceeds from put option if exercised (3,000,000 x strike price) A$ 5,040,000.00 A$ 4,920,000.00
Less cost of premium, including time-value (77,490.00) (51,660.00)
Net proceeds from put options, in 90-days: Minimum A$4,962,510.00 A$4,868,340.00

Analysis: Susan Martin would receive the most certain A$ from the forward contract, A$5,019,900; the money market hedge is less
attractive as a result of the now higher borrowing costs in Germany. The two put options yield unattractive amounts if they had to be
exercised.

This study source was downloaded by 100000841150731 from CourseHero.com on 03-13-2022 05:05:34 GMT -05:00

https://www.coursehero.com/file/13917309/Tutorial-6-Solutions-Chap10-3A14/
Powered by TCPDF (www.tcpdf.org)