1.    How do you think the hedge will accomplish Carolina Furniture Company’s objective of protecting the value of its foreign currency cash flows?


Answer:


Accordingly, a hedge is a financial investment which is taken out in purpose of reducing or canceling out financial risks in another investment. The strategy which is designed to lessen the exposure of finances to an unwanted business risk is called hedging. This strategy still permits the business to gain from an investment operation. It is noted that one of the primary goal of an industry, like for example the Carolina Furniture Company, is to protect the value of its foreign currency cash flows. The hedge can be able to help or assists CFC in its objective by making sure that the organisation is not losing cash due to the changes in line with exchange rate. One is through the use of foreign currency cash flow hedging currency hedging.


The hedge will enable the company to manage the risks that will encounter. Furthermore, foreign currency hedging can help CFC to minimise the effects of foreign exchange risks and be able to sustain the capability of the foreign currency cash flows. The way firms manage the exchange-rate risk associated with their transactions depends on the nature of, and market for, the good or service for which they are exchanging value. Accordingly, hedging strategies vary considerably between exporters and importers, between export sectors, and between firms in a given sector. While revenues may be sensitive to exchange-rate movements at the individual firm level, they are more stable in aggregate across industrial sectors, across exports and across the economy as a whole, indicating that risk is well diversified


 


2.    What are the expected cash flows from the DM transaction if it is hedged in the forward market?


Answer:


If transaction of DM 2,000,000 will fall in a 180-day forward rate at .5700, the expected cash flows after hedging will amount to US,140,000.


 


3.    How would the DM inflows be hedged in the money market? If this transaction is hedged in the money market, what are the expected cash flows?


Answer:


      The Money market hedging has been formulated on the notion of creating an opposite currency for the similar amount to the flow which will undergo hedging. In this instance, since the receivables which will be hedged is an inflow of DM2, 000,000 to be received in a 180-day period, it is important to make a   DM2, 000,000 outflows in 180 days.  In this case, in the money market hedge, the DM 2,000,000 can be subjected into to two various interest rates from the currency loan; namely, US0,940.80 if this will be acquired in prime rate while US9,193.60 if acquired in LIBOR (London). For this instance, , the total money would be US,023,859.20 while the latter is US,025,606.40 with a difference of US,747.20 in favor of the LIBOR. 


4.    Given the answer to the two previous questions, which alternative would you choose to hedge the DM transaction?


Answer:


Based on the computations above, it can be said that the best alternative that could be chosen to hedge the DM transaction is the first option which is the money market hedge. Given the condition of German Transaction done by the CFC, money market hedge is chosen because of its compatibility in the given LIBOR’s lower interest rate. Hence, the currency risk of the Carolina Furniture Company in line with having investment in the money market is lessening or mitigating.


 


 


5.    What are the expected cash flows from the JY transaction if it is hedged in the forward market?


Answer:


If transaction of JY falls in a 90-day forward rate, the expected cash flows after hedging will amount to US,118,100,000.00.


 


6.    How would the JY inflows be hedged in the money market? If this transaction is hedged in the money market, what are the expected cash flows?


Answer:


The Money market hedging has been formulated on the notion of creating an opposite currency for the similar amount to the flow which will undergo hedging. In this instance, since the receivables which will be hedged is an inflow of JY to be received in a 90-day period, it is important to make a   JY outflows in 90 days. If the Japan transaction will be quoted in terms of prime rate, the expected cash flow would be US,049,349,600. On the other hand, if this will be quoted in LIBOR it will be US,051,703,910 with a difference of US,354,310.  Due to substantial amount of the transaction, it can be hedged in the money market through cross-country investment.


 


7.    What should be done regarding the JY inflows? Why?


Some Multinational organisations are now approaching liquidation which can be noticed by the sale of stake in its finance subsidiary.  In this case, if the interest rate different between the currency of Japan and US, it is considered that this main hindrance for the investments of industries in the United States, With this situation, one can assume that it is more advantageous to invest in Japan, Multinational companies may appeal for the government’s action to hold more Japanese yen or encourage some activities in terms of exports as an economic approach. When this option has been implemented there is a possibility that the strength of US dollar in its spot rate will now appreciate offsetting the lower interest rate. In addition, stability may also be achieved by merely increasing the interest rate. However, such action may lead to inflation. With this, the local currency effects can be reconsidered as a way to achieved parity and uniformity.     For this period, the following situations can be attached to the Japan transaction. First, the client is largely positioned in the capital city of the country, In this condition, the payment for transaction will be in September 1991 and the orders for this transaction was already been shipped last. In this case, it is said that the client holds a large bargaining power position. Hence, Carolina Furniture Company must be able to find ways on making this client stay with the company. 


 


8.    What would be the net cash flows to Carolina Furniture Company by hedging the S$ cash flows in the money market?


Answer:


            If the S$ cash flows will be hedged in money market, it can be assumed that the net cash flows of Carolina Furniture Company or the expected cash flows will be US1,866.03. 


 


Appendices


 


Germany


Japan


Singapore1


Sing 2


Sale price (DM)


 2,000,000.00


1.5E+11


 250,000.00


 250,000.00


Remarks


Hotel client, opening, parts of order alerady shipped, last consignment on second week of Oct 1991, payment will be given on Nov. 14


large trading company in Tokyo, payment will be given on Sep 18, 1991, shipped on Aug


due on nov 23, 1991 from furniture retailer, shipped in the last week of july


another from the same company on 2/17/92, shipment will be made on December 1991


 


Cash flow in the forward market


 


 


 


 


 


Contract Price


Spot


30-day forward


90-day forward


180-day forward


Germany


           2,000,000.00


         1,164,800.00


        1,159,200.00


       1,146,600.00


        1,140,000.00


Japan


1.5E+11


   1,121,100,000.00


 1,120,500,000.00


 1,118,100,000.00


  1,115,250,000.00


Sing 1


              250,000.00


            143,700.00


 


 


 


Sing 2


              250,000.00


            143,700.00


 


 


 


TOTAL


     1,121,934,000.00


 


 


 


 


PREVIOUS


 


 


 


 


 


 


 


 


 


 


 


In the money market


 


 


 


 


 


Contract Price


1-month


3-months


6-months


 


Germany


           2,000,000.00


 


          140,940.80


 


 


Japan


1.5E+11


7.2E+07


 


 


 


Sing 1


              250,000.00


 


              7,515.51


 


 


Sing 2


              250,000.00


 


 


              8,018.46


 


 


 On LIBOR


 


 


 


 


Germany


              139,193.60


 


 


 


 


Japan


6.9E+07


 


 


 


 


Sing 1


 


 


 


 


 


Sing 2


 


 


 


 


 


 


 


 


 


 


 


 


Total at prime rate


Total at LIBOR rate


 


 


 


Germany


           1,023,859.20


         1,025,606.40


 


 


 


Japan


     1,049,349,600.00


   1,051,703,910.00


 


 


 


Sing 1


              136,184.49


 


 


 


 


Sing 2


              135,681.54


 


 


 


 


 


     1,050,645,325.23


   1,052,729,516.40


 


 


 


 


              


 


 


 



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