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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 2
1. Decision Case: ZAPA Chemical & Buba
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 4
Zapa Chemical and Buba
b. What are the hedge alternatives for Zapa
Chemical’s exposure?
• Remain uncovered
– Maximum risk approach (full exposure)
– Spot exchange rate: DM1.4649/$
$ 5,188,067
• Forward cover
– Sell DM forward
– 120-day forward rate: DM1.4957/$ (annual discount of 6.2%)
$ 5,081,233
• Foreign currency option
– Buy put option on DM
– Strike price: DM1.5152/$ (or $0.66/DM) [out of the money]
– Premium: 1.40 cents per DM (0.0140/0.66 = 2.1%)
– Total outlay for protection: $106,400 (= $0.014 * 7.6 million)
Worst Case: $ 4,908,264 (=7.6 million/1.5152 – $106,400*(1+(0.033125%*120/360))
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 5
Hedge Alternatives
US dollars Uncovered
(millions)
Forward cover
5.1
5.0
4.9 Put option on
DM
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 7
Zapa Chemical and Buba
Comparison of different hedging strategies
(DM/$ ) Sep 18th (DM/$ ) Dec 15th
•Sale of put option & forward hedge (at DM 1.5255/$) lead to higher
outcome than option hedge in the worst case as well as at the
current spot rate.
•Forward hedge does not allow to benefit from falling US dollar.
•Why not uncovered position or replacing option?
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Professur für BWL, insb. nternationale Wirtschaft 1)
106,400*(1+(0.033125%*120/360);
International Financial Management see slide no. 5 8
Zapa Chemical and Buba
d. How have the events of September altered
Stephanie’s view of the DM/$ exchange rate?
• Initially, Stephanie expected the dollar to fall further:
– Buba was driving interest rates up to slow monetary growth
– Interest rate differentials (US: 3.3125%; Germany: 9.750%)
• September turbulence:
– Uncertainty in Europe due to French vote on Maastricht Treaty
– Stress in the EMS (devaluation pressure on LIT and GBP);
GBP and LIT withdrawn from ERM
– Spanish peseta devalued 5%
• After the dollar had fallen, risen, and fallen again, she
wished to reevaluate her put option position.
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 9
Zapa Chemical and Buba
e. How has the volatility of the put option changed
between August and September?
• Volatility of the put option has increased
– August: premium oscillated between $0.5 and $1.50 per DM
– September: premium oscillated between $0.5 and $2.50 per DM
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 10
Zapa Chemical and Buba
f. What benchmarks would you use to measure the hedging
effectiveness? How would this alter Stephanie’s hedging?
• ZAPA considers Treasury a cost center (not a profit center!).
– Primary responsibility: conservative management of exposure.
– “Management was appreciative when the expenses of running the cost
center were lower” (p. 239).
• Consequence:
– Cost as a benchmark to measure hedging effectiveness
– Standard portfolio theory:
maximize the expected value µ, minimize the variance ( σ = risk )
2
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 11
2. Delphi‘s Currency Swap
Eiteman/Stonehill/Moffett, p. 394-395
Delphi’s Currency Swap
Delphi:
Decision:
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 13
Delphi’s Currency Swap
a. What would be the annual swap payments on a
$50 million notional principal, 7 year maturity
currency swap?
Interest
Interestto
to
receive
receiveinin$$
Interest
Interestto
to
pay
payininEuro
Euro
Notional
5.86
5.86%% 105.86
105.86%%
principal ($50,000,000)
($50,000,000) $2,930,000 $52,930,000
$ Cash Flow $2,930,000 $52,930,000
(to receive)
Notional
principal 4.05
4.05%% 104.05
104.05%%
(€43.103.448)
(€43.103.448)
€ Cash Flow €1,745,690
€1,745,690 €44.849.138
€44.849.138
(to pay)
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 15
Delphi’s Currency Swap
b. What is the net present value of the swap
agreement when unwinding Delphi’s currency
swap after 3 years?
• Assumptions:
– Change of interest rates
¾ Four-year fixed rate of interest in Euros: 5.35% (previously 4.05%)
¾ Four-year fixed rate of interest in Dollar: 4.40% (previously 5.86%)
– Change of exchange rate
¾ from $1.16/€ to $1.02/€
• Necessary Calculations:
– PV of remaining cash flows in Dollar
– PV of commitment in Euro
– Settlement
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 16
Delphi’s Currency Swap
b. Net present value of the swap
Delphi
Delphireceives
receivesaanet
netpayment
paymentof
of$10,669,840
$10,669,840(due
(dueto
to ++
changes 10,669,840
changesinininterest
interestrates
ratesand
andDollar
Dollarappreciation)
appreciation) 10,669,840
€ Present
41,132,542
41,132,542€€
Value €1,745,690/ €1,745,690/ €1,745,690/ €44.849.138/
€1,745,690/ €1,745,690/ €1,745,690/ €44.849.138/ xx$1.02/€
$1.02/€
1.0535 1 1.0535 2 1.0535 3 1.0535 4
(to pay) 1.0535 1 1.0535 2 1.05353 1.05354 ==
Int. rate: 5.35% $41,955,193
$41,955,193
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 17
3. Ikea’s Yen Exposure
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 19
Ikea’s Yen Exposure
• Ikea’s purchase is invoiced in Japanese yen
• Exposure: 90-day account payable of ¥2.7 billion
• Use of currency option to manage exposure
• Need to finance option purchases by writing offsetting
positions Ö construction of a range forward
• Current market conditions
– Spot exchange rate: ¥ 108.20/$= $0.009242/ ¥
– 90-day forward rate: ¥ 107.88/$= $0.009270/ ¥
– 90-day Eurodollar deposit rate: 3.3750%
– 90-day Euroyen deposit rate: 2.1875%
– 90-day yen/dollar volatility quote: 11.8%
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 20
Ikea’s Yen Exposure
Range Forward in the Ikea Case
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 21
Ikea’s Yen Exposure
Construct and diagram a range forward that is +/-2%
(+/- 3.5%) around the forward rate
• Alternative a) +/- 2%
– Forward rate: ¥107.88/$= $0.009270/ ¥
- Upper bound: ¥105.72/$= $0.009459/ ¥ (Strike price Call)
- Lower bound: ¥110.04/$= $0.009088/ ¥ (Strike price Put)
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 22
Range Forward Diagram
US$ Uncovered
Account
payable
Buy a call
-25,935,807
-25,542,251 Sell a put
-25,027,809
Range forwards
-24,540,738
-24,181,712 2%
Forward cover
3.5%
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 24
Ikea’s Yen Exposure
Calculation of Option Premiums
• Currency Option Pricing Theory
European call option C = [FN (d1) − EN (d 2)]e − rd T
⎛ F ⎞ ⎛σ ⎞
2
ln⎜ ⎟ + ⎜⎜ ⎟⎟T
⎝E⎠ ⎝ 2 ⎠ d 2 = d1 − σ T
d1 =
σ T
• Premium payments
Strike -2% Strike + 2% Strike - 3,5% Strike + 3,5%
Call $/¥ 0,000315 0,000136 0,000402 0,00009126
Put $/¥ 0,000135 0,000324 0,00009117 0,000425
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 25
Ikea’s Yen Exposure
b. (ctd.) US dollar proceeds if ending spot exchange
rate is $0.0096/ ¥ ~ 104.17 ¥/$ Call Option Strike Rate
¥104.10/$= $0.009606/ ¥
+/- 2% +/-3.5%
Call Option Strike Rate Call Call
Calloption
Calloption
option not
option
exercised
¥105.72/$= $0.009459/ ¥ exercised not exercised
exercised
Dollar proceed -$ 25,538,580 -$ 25,920,000
~~¥2.7 billion*$0.009459/¥
¥2.7billion *$0.009459/¥ ==¥2.7 billion*$0.0096/¥
¥2.7billion *$0.0096/¥
Outlay for call option - $ 367,246 -$ 246,415
~~¥2.7
¥2.7billion
billion* *¢0.0136/
¢0.0136/¥¥ ~~¥2.7
¥2.7billion
billion* *¢0.009126/
¢0.009126/¥¥
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Professur für BWL, insb. nternationale Wirtschaft
International Financial Management 26
Ikea’s Yen Exposure
c. Minimum US dollar proceeds
Call Option Strike Rate
¥104.10/$= $0.009606/ ¥
+/- 2% +/-3.5%
Call Option Strike Rate Call Call
Calloption
Calloption
option option
exercised
¥105.72/$= $0.009459/ ¥ exercised exercised
exercised
Dollar proceed -$ 25,538,580 -$ 25,935,553
~~¥2.7 billion*$0.009459/¥
¥2.7billion *$0.009459/¥ ~~¥2.7 billion*$0.009606/¥
¥2.7billion *$0.009606/¥
Outlay for call option - $ 367,246 -$ 246,415
~~¥2.7
¥2.7billion
billion* *¢0.0136/
¢0.0136/¥¥ ~~¥2.7
¥2.7billion
billion* *¢0.009126/
¢0.009126/¥¥