International Finance Management. Read the
Dozier Industries (A) Case.
Case A: Additional Information is
provided below.
·
You should treat January
14, 1986, as the date when you are performing your analysis and acting on the
analysis (hedging or not hedging).
·
The prime rate is the
rate at which the bank lends to its most creditworthy corporate customers. It
is lending from the banks perspective, but borrowing from Dozier’s perspective.
·
Deposits are borrowing
on the part of a bank, but lending from the perspective of a customer such as
Dozier.
·
To reduce risk, Dozier
will take the 10% initial deposit (pounds) and sell the pounds in the spot
market on Jan 14.
·
Any dollars that Dozier
receives on Jan 14 are deposited in the bank for 90 days.
Read the (A) case, and then
address the following questions:
1.
If Dozier uses the
forward contract to hedge, what is Dozier’s profit in US dollars?
·
(Hint: Since Dozier’s motive is hedging, you first
calculate the revenue in dollars that Dozier will receive for the Pound receivable.
Then subtract Dozier’s Costs given in exhibit 3).
2.
If Dozier uses the spot
transaction suggested in the case, what is Dozier’s profit in US dollars?
·
(Hint: Since Dozier’s motive is hedging, you first
calculate the revenue in dollars that Dozier will receive for the Pound
receivable. Then subtract Dozier’s Costs given in exhibit 3. Hint 2: The case gives you instructions on how to
construct a spot transaction hedge (also known as a money market hedge). To
properly hedge, keep in mind that your pound inflows (the receivable) and
outflows (loan repayment) must be equal. This means that the future value of
the loan (total loan repayment including interest) must equal the receivable.
If the amount borrowed (a present value) is equal to the receivable, then the
loan repayment (pound outflow) will be greater than the receivable (pound
inflow) and you will not be hedged.)
3.
Given the data in
exhibit 5, calculate all 12 week (approximately 90 days) percentage changes in
the exchange rate. There will be 16 to calculate (e.g. 7-9-85 to 10-1-85,
7-16-85 to 10-08-85,…, 10-22-85 to 1-14-86). Take the absolute value of each
percentage change. What is the largest percentage change? What is the average
percentage change?
4.
Assume that the
percentage decrease in value of the pound
is equal (in absolute value; the direction of the change, positive or negative,
may differ) to the largest percentage
change in the pound. Calculate Dozier’s profit or loss in US dollars from
remaining unhedged.
5.
Assume that the
percentage increase in value of the pound
is equal (in absolute value; the direction of the change, positive or negative,
may differ) to the largest percentage
change in the pound. Calculate Dozier’s profit or loss in US dollars from
remaining unhedged.
6.
Assume that the percentage decrease in value of the pound is equal (in
absolute value; the direction of the change, positive or negative, may differ)
to the average percentage change in the pound. Calculate
Dozier’s profit or loss in US dollars from remaining unhedged.
7.
Assume that the
percentage increase in value of the pound
is equal (in absolute value; the direction of the change, positive or negative,
may differ) to the average percentage
change in the pound. Calculate Dozier’s profit or loss in US dollars from
remaining unhedged.
8.
Would you recommend that
Dozier use the forward hedge, spot transaction hedge, or remain unhedged?
Explain.
·
(Hint: the comparison between the forward hedge and the
spot transaction hedge should be straightforward because the risk is the same.
However, if unhedged, the risk is greater. You will need to read the case
carefully and use the information given in the case about Dozier along with
your answers to questions above to make an argument for whether Dozier should
hedge or remain unhedged.)
