Problem 10.1 BioTron Medical, Inc.

Brent Bush, CFO of a medical device manufacturer, BioTron Medical, Inc., was approached by
a Japanese customer, Numata, with a proposal to pay cash (in yen) for its typical orders of
¥12,500,000 every other month if it were given a 4.5% discount. Numata's current terms are 30
days with no discounts. Using the following quotes and estimated cost of capital for BioTron,
Bush will compare the proposal with covering yen payments with forward contracts.

Spot rate, ¥/$ ¥111.40/$

30-day forward rate, ¥/$ ¥111.00/$
90-day forward rate, ¥/$ ¥110.40/$
180-day forward rate, ¥/$ ¥109.20/$
Numata's WACC 8.850%
BioTron Medical's WACC 9.200%

How much in U.S. dollars will BioTron Medical receive 1) with the discount and 2) with no
discount but fully covered with a forward contract?

Assumptions Values
BioTron's 30-day account receivable, Japanese yen 12,500,000
Spot rate, ¥/$ 111.40
30-day forward rate, ¥/$ 111.00
90-day forward rate, ¥/$ 110.40
180-day forward rate, ¥/$ 109.20
Numata's WACC 8.850%
BioTron Medical's WACC 9.200%
Desired discount on purchase price by Numata 4.500%

Brent Bush should compare two basic alternatives, both of which eliminate the currency risk.

1. Allow the discount and receive payment in Japanese yen in cash

 Account recievable (yen) 12,500,000
Discount for cash payment up-front (4.500%) 562,500
Amount paid in cash net of discount 11,937,500

Current spot rate 111.40

Amount received in U.S. dollars by Seattle Scientific $ 107,158.89

2. Not offer any discounts for early payment and cover exposure with forwards

Account receivable (yen) 12,500,000

30-day forward rate 111.00
Amount received in cash in dollars, in 30 days $ 112,612.61

30-day WACC discount factor 1.007666666667

Present value $ 111,755.82
Problem 10.2 Bobcat Company

Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces
plastic nuts and bolts for heavy equipment. The purchase price was Won7,500 million. Won1,000 million has already
been paid, and the remaining Won6,500 million is due in six months. The current spot rate is Won1,110/$, and the 6-
month forward rate is Won1,175/$. The six-month Korean won interest rate is 16% pe annum, the six-month US
dollar rate is 4% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A
six-month call option on won with a 1200/$ strike rate has a 3.0% premium, while the six-month put option at the
same strike rate has a 2.4% premium.

Bobcat can invest at the rates given above, or borrow at 2% per annum above those rates. Bobcat's weighted average
cost of capital is 10%. Compare alternate ways that Bobcat might deal with its foreign exchange exposure. What do
you recommend and why?

Assumptions Values
Purchase price of Korean manufacturer, in Korean won 7,500,000,000
Less initial payment, in Korean won (1,000,000,000)
Net settlement needed, in Korean won, in six months 6,500,000,000
Current spot rate (Won/$) 1,110
Six month forward rate (Won/$) 1,175
Bobcat's cost of capital (WACC) 10.00%

Options on Korean won: Call Option Put Option

Strike price, won 1,200.00 1,200.00
Option premium (percent) 3.000% 2.400%

United States Korea

Six-month investment (not borrowing) interest rate (per annum) 4.000% 16.000%
Borrowing premium of 2.000% 2.000% 2.000%
Six-month borrowing rate (per annum) 6.000% 18.000%

Risk Management Alternatives Values Certainty

1. Remain uncovered, making the won payment in 6 months
at the spot rate in effect at that date
Account payable (won) 6,500,000,000
Possible spot rate in six months: current spot rate (won/$) 1,110
Cost of settlement in six months (US$) $ 5,855,855.86 uncertain

Account payable (won) 6,500,000,000

Possible spot rate in six months: forward rate (won/$) 1,175
Cost of settlement in six months (US$) $ 5,531,914.89 uncertain

2. Forward market hedge. Buy won forward six months

Account payable (won) 6,500,000,000

Forward rate (won/$) 1,175.00
Cost of settlement in six months (US$) $ 5,531,914.89 certain

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

Account payable (won) 6,500,000,000

Discount factor at the won interest rate for 6 months 0.92593
Won needed now (payable/discount factor) 6,018,518,518.52
Current spot rate (won/$) 1,110.00
US dollars needed now $ 5,422,088.76
Carry forward rate for six months (WACC) 10.000%
US dollar cost, in six months, of settlement $ 5,693,193.19 certain

4. Call option hedge. (Need to buy won = call on won)

If exercised If not exercised
Option principal 6,500,000,000 6,500,000,000
Current spot rate (won/$) 1,110.00 1,300.00
Premium cost of option (%) 3.000%
 Option premium (principal/spot rate x % pm) $ 175,675.68

If option exercised/not exercised, dollar cost of won $ 5,416,666.67 $ 5,000,000.00 1300

Premium carried forward six months (pm x 1.125, WACC) 184,459.459 184,459.46
Total net cost of call option hedge if exercised $ 5,601,126.13 $ 5,184,459.46
Maximum.
Problem 10.4 P & G India
Proctor and Gamble’s affiliate in India, P & G India, procures much of its toiletries product line from a Japanese
company. Because of the shortage of working capital in India, payment terms by Indian importers are typically 180
days or longer. P & G India wishes to hedge a 8.5 million Japanese yen payable. Although options are not available
on the Indian rupee (Rs), forward rates are available against the yen. Additionally, a common practice in India is for
companies like P & G India to work with a currency agent who will, in this case, lock in the current spot exchange
rate in exchange for a 4.85% fee. Using the following exchange rate and interest rate data, recommend a hedging
strategy.

Assumptions Values
180-day account payable, Japanese yen (¥) 8,500,000
Spot rate (¥/$) 120.60
Spot rate, rupees/dollar (Rs/$) 47.75
Implied (calculated) spot rate (¥/Rs) 2.5257 (120.60 / 47.75)
180-day forward rate (¥/Rs) 2.4000
Expected spot rate in 180 days (¥/Rs) 2.6000
180-day Indian rupee investing rate 8.000%
180-day Japanese yen investing rate 1.500%
Currency agent's exchange rate fee 4.850%
P & G India's cost of capital 12.00%
Spot Risk
Hedging Alternatives Values Rate (¥/Rp) Assessment

1. Remain Uncovered, settling A/P in 180 days at spot rate

If spot rate in 180 days is same as current spot 3,365,464.34 2.5257 risky

If spot rate in 180 days is same as forward rate $ 3,541,666.67 2.4000 risky

If spot rate in 180 days is expected spot rate 3,269,230.77 2.6000 risky

2. Buy Japanese yen forward 180 days

 Settlement amount at forward rate (Rs) 3,541,666.67 certain

3. Money Market Hedge

Principal A/P (¥) 8,500,000.00
discount factor for yen investing rate for 180 days 1.0075
Principal needed to meet A/P in 180 days (¥) 8,436,724.57

Current spot rate (¥/Rs) 2.5257

Indian rupee, current amount (Rs) 3,340,411.26
P&G India's WACC carry-forward factor for 180 days 1.0600
Future value of money market hedge (Rs) 3,540,835.94 certain

4. Indian Currency Agent Hedge

Principal A/P (¥) 8,500,000.00
Current spot rate (¥/Rs) 2.5257
Current A/P (Rs) 3,365,464.34

Plus agent's fee (4.850%) 163,225.02

P & G India's WACC carry-forwad factor for 180 days on fee 1.0600
Total future value of agent's fee (Rs) 173,018.52

Total A/P, future value, A/P + fee (Rs) 3,538,482.87