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On Friday, November 2, 2007, Mikalya Cain, Chief Financial Officer of Pixonix Inc., sat in
her office and pondered the impact of the strong Canadian dollar on her firms projected
financial results. The Report on Business today stated that the Canadian dollar had hit another
record, jumping to US$1.0717 from the previous days close of US$1.0512after a stronger
than expected jobs report reduced the odds of an interest- rate cut. The Canadian dollar had
already been the worlds best performing major currency this year, increasing 25% against
the U.S dollar and almost seven per cent in the past month alone. Cain knew she would have
to understand the impact of the strong dollar on her firms cash flows and the tools available
to manage the companys currency risk.
The Company
Pixonix was a graphic design company that operated in Toronto, Canada. At the annual cost
of USD 7.5 million, the company licensed proprietary tools and software through a U.S
company; this payment was due at the end of January each year. While all of the companys
revenues were denominated in Canadian dollars, a significant portion of its expenses were
paid in U.S dollars. Therefore, Pixonix had to annually convert its Canadian dollar cash flows
into U.S dollars. As the Canadian dollar strengthened, cash flow and profitability had been
positively impacted, but Cain faced a considerable amount of uncertainty about the value of
the Canadian dollar at the end of January, when she would have to purchase USD 7.5 million.
7.5 million. Refer Exhibit I for the current forward rate of the U.S dollar. Exhibit II shows the
details on various call and put options of USD.
0.9351
Ask
0.935130
0.935010
0.934990
0.935510
0.936700
0.940940
If the most optimistic value of USD is expected to be 0.90 CAN $, most likely to be 1 CAN $
and the most pessimistic to be 1.10 CAN$, how would you evaluate the strategies?
Henderson Corporation
Henderson Corporation, located in Australia, manufactures ball bearings for an entity located
in Singapore. It has just made a shipment to Singapore and expects to receive S$250000 in 30
days. However, the board of directors at Henderson is worried that the Australian dollar will
strengthen significantly in the near term against the Singapore dollar. The current spot rate is
1.26AUD/S$ and expected spot rate after 30 days is 1.22AUD/S$. So it has instructed the
CEO to consider hedging the S$ receivables and bring a proposal for consideration to the
next board meeting. The CEO has asked you to develop the proposal for her consideration.
The proposal needs to consider several hedging alternatives and the relative costs and
benefits of each alternativeTo conduct the analysis you have collected the following informationa. Current quote from a Singapore bank is that loans can be obtained for S$ @1.5% for
one month and investments in AUD will fetch 2% for one month.
b. S$ put options with an exercise price of $1.31 and with a premium of $0.05 currently
exist. The spot rate for S$ due in 30 days is expected to be 1.28(33% probability) or
1.30(33% probability), 1.32(34% probability).
c. The quote obtained for the 30-day forward rate 1.30 AUD/S$.
There are many ways that this risk can be dealt with and a single way to proceed is hard to
determine. Alternatives include using foreign exchange and options markets or diversifying
sources of sales revenues or production costs. After consideration of the situation you have
decided that three strategies could be pursued- a money market hedge, an option hedge and a
forward hedge. These are the least disruptive to the balance sheet and are relatively short term
in nature, which fits the nature of the risk being managed.