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Unformatted text preview: Problem 8.1 Lipitor in Indonesia Evaluating the costs of hedging transaction exposure. Assumptions Values Receivable due in 3 months, in Indonesian rupiah (Rp) Rp750,000,000 Spot rate, Rp/$ 8,800 Expected spot rate in 90 days, Rp/$ 9,400 3-month forward rate, Rp/$ 9,800 Minimum dollar amount acceptable at settlement $78,000.00 Risk Alternatives Values Assessment 1. Remain Uncovered. Settle A/R in 90 days at current spot rate. If spot rate in 90 days is same as current $85,227.27 Risky (Rp750,000,000 / Rp8,800/$) If spot rate in 90 days is Rp9,400/$ $79,787.23 Risky (Rp750,000,000 / Rp9,400/$) If spot rate in 90 days is Rp9,800/$ $76,530.61 Risky (Rp750,000,000 / Rp9,800/$) 2. Sell Indonesian rupiah forward. A/R sold forward 90 days $76,530.61 Certain "Cost of cover" is the forward discount on Rp-40.8% Analysis The Indonesian rupiah has been highly volatile in recent years. This means that during the 90-day period, any variety of economic or political or social events could lead to an upward bounce in the exchange rate, reducing the dollar proceeds at settlement to an unacceptable level. Unfortunately, the forward contract does not result in dollar proceeds which meet the minimum margin. The forward cover yields dollar proceeds of only $76,530.61, short of the needed $78,000. The cost of forward cover, 40.8%, is indicative of the "artificial interest rates" used by some financial institutions while pricing derivatives in emerging, illiquid, and volatile markets. In the end, Pfizer will have to decide whether making the sale into this specific market is worth breaking a company policy on minimum proceeds (forward cover) or taking significant currency risk by not using forward cover. Problem 8.2 Embraer of Brazil Advise Embraer on currency exposure. Assumptions Values Receivable due in one year, US dollars $80,000,000 Payable due in one year, US dollars $20,000,000 Spot rate, R$/$ 3.40 One-year US dollar eurocurrency interest rate 4.00% One-year Brazilian govt deposit note 14.00% Implied one year forward rate = spot x ( 1 + iR$ ) / ( 1 + i$ ) 3.7269 Risk Analysis Values Assessment Net exposure at time of cash settlements: One year A/R due $80,000,000 One year A/P due $(20,000,000) Net exposure $60,000,000 Certain This is a net long position, meaning, Embraer will be receiving US dollars on net. Given the history of the Brazilian real, that it has traditionally suffered from rapid depreciation and occasional devaluation, a net long position in dollars by most Brazilian companies is considered a good thing. Cash settlement of the net position: Brazilian reais in one year at current spot rate R$ 204,000,000.00 Risky Brazilian reais in one year at one year forward rate R$ 223,615,384.62 Certain In this case, however, because the real is selling forward at a considerable discount, the net long position -- if sold forward -- yields considerably more real than the current spot rate....
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- Spring '11