How would the appropriate hedge change if the German affiliates functional currency were the U.S. dollar?
Questions
1. What is translation exposure? Transaction exposure?
2. What are the basic translation methods? How do they differ?
3. What factors affect a company’s translation exposure? What can the company do to affect its degree of translation exposure?
4. What alternative hedging transactions are available to a company seeking to hedge the translation exposure of its German subsidiary? How would the appropriate hedge change if the German affiliate’s functional currency were the U.S. dollar?
5. In order to eliminate all risk on its exports to Japan, a company decides to hedge both its actual and anticipated sales there. To what risk is the company exposing itself? How could this risk be managed?
6. Instead of its previous policy of always hedging its foreign currency receivables, Sun Microsystems has decided to hedge only when it believes the dollar will strengthen. Otherwise, it will go uncovered. Comment on this new policy.
7. Your bank is working with an American client who wishes to hedge its long exposure in the Malaysian ringgit. Suppose it is possible to invest in ringgit but not borrow in that currency. However, you can both borrow and lend in U.S. dollars.
a. Assuming there is no forward market in ringgit, can you create a homemade forward contract that would allow your client to hedge its ringgit exposure?
b. Several of your Malaysian clients are interested in selling their U.S. dollar export earnings forward for ringgit. Can you accommodate them by creating a forward contract?
8. Eastman Kodak gives its traders bonuses if their selective hedging strategies are less expensive than the cost of hedging all their transaction exposure on a continuous basis. What problems can you foresee from this bonus plan?
9. Many managers prefer to use options to hedge their exposure because it allows them the possibility of capitalizing on favorable movements in the exchange rate. In contrast, a company using forward contracts avoids the downside but also loses the upside potential as well. Comment on this strategy.
10. In January 1988, Arco bought a 24.3% stake in the British oil firm Britoil PLC. It intended to buy a further $1 billion worth of Britoil stock if Britoil were agreeable. However, Arco was uncertain whether Britoil, which had expressed a strong desire to remain independent, would accept its bid. To guard against the possibility of a pound appreciation in the interim, Arco decided to convert $1 billion into pounds and place them on deposit in London, pending the outcome of its discussions with Britoil’s management. What exchange risk did Arco face, and did it choose the best way to protect itself from that risk?
11. Sumitomo Chemical of Japan has one week in which to negotiate a contract to supply products to a U.S. company at a dollar price that will remain fixed for one year. What advice would you give Sumitomo?
12. U.S. Farm-Raised Fish Trading Co., a catfish concern in Jackson, Mississippi, tells its Japanese customers that it wants to be paid in dollars. According to its director of export marketing, this simple strategy eliminates all its currency risk. Is he right? Why?
13. The Montreal Expos are a major-league baseball team located in Montreal, Canada. What currency risk is faced by the Expos, and how can this exchange risk be managed?
14. General Electric recently had to put together a $50 million bid, denominated in Swiss francs, to upgrade a Swiss power plant. If it won, GE expected to pay subcontractors and suppliers in five currencies. The payment schedule for the contract stretched over a five-year period.
a. How should General Electric establish the Swiss franc price of its $50 million bid?
b. What exposure does GE face on this bid? How can it hedge that exposure?
15. Dell Computer produces its machines in Asia with components largely imported from the United States and sells its products in various Asian nations in local currencies.
a. What is the likely impact on Dell’s Asian profits of a strengthened dollar? Explain.
b. What hedging technique(s) can Dell employ to lock in a desired currency conversion rate for its Asian sales during the next year?
c. Suppose Dell wishes to lock in a specific conversion rate but does not want to foreclose the possibility of profiting from future currency moves. What hedging technique would be most likely to achieve this objective?
d. What are the limits of Dell’s hedging approach?