Blades Corporation Essay

1. If Blades uses call options to hedge its yen payables, should it use the call option with the exercise price of $0.00756 or the call option with the exercise price of $0.00792? Describe the tradeoff. The corporation needs to purchase supplies with foreign currency. To hedge against the possible appreciation of the foreign currency’s value, the corporation can purchase a call option. Both options have to pay a premium for the option. The purchase price or exercise price of option A is $0.00756 plus a premium paid on this respective option of $.0001512 resulting in a total cost of $.0077112 per yen. The purchase or exercise price of option B is $0.00792 plus a premium paid of $.0001134 resulting in a total cost of $.0080334 per yen. Option A is the better option, relatively. Option B has a higher exercise price, though its exercise price is lower, the overall result is a higher amount paid for yen if the option is exercised. If the option is likely not to be exercised, option B is the best choice. The corporation would only have to pay the premium price and not the exercise price. In this case, option B’s premium price is lower. The trade off is between a lower exercise price, higher premium price, option A, that better hedges against the yen if it were to appreciate in value (exercising the option) and a higher exercise price, lower priced premium that reduces cost if the hedge does not appreciate in value (the option is not exercised). 2.Should Blades allow its yen position to be unhedged? Describe the tradeoff. The case stated that â€Å"the futures price on yen has historically exhibited a slight discount from the existing spot rate†. In this case, the exercise price of the option may be higher relative to the future spot rate encouraging the investor to let the option expire. If the option were to expire the corporation would still have to pay the premium and any other non-exercise costs. An unhedged position might be the best position if this were to occur because there would be no premium charges. The disadvantage to an unhedged position is that if the exercise price of the option were to be ‘in the money’, the spot exchange rate is greater than the exercise price, there would be no hedged stance against the yens appreciated value causing a higher cost to the foreign currency payable. Chap 6 1.Did the intervention effort by the Thai government constitute direct or indirect intervention? Explain. The Thai government is trying to smooth exchange rate movements by encouraging appreciation of its currency through direct intervention. It is exchanging foreign currencies for its home currency in the exchange market, this will put upward pressure on home currency. Specifically, the Thai government swapped baht reserves for dollar reserves at other central banks and then used its dollar reserves to purchase the baht in the foreign exchange market. 2.Did the intervention by the Thai government constitute sterilized or non sterilized intervention? What is the difference between the two types of intervention? Which type do you think would be more effective in increasing the value of the baht? Why? (Hint: Think about the effect of nonsterilized intervention on U.S. interest rates.) The intervention of the Thai government is an example nonsterilized intervention because the Thai government did not simultaneously engage in offsetting the described transactions in the securities market. This would have resulted in the net money supply to be unchanged. Both interventions will achieve the same exchange of currency in the exchange market but sterilized intervention requires another transaction to prevent adjustments in the money supply. An increase in money supply, as would be the effect in nonsterilized intervention, would cause home interest rates to drop and makes more money available for consumers to borrow from banks. Investors may transfer funds to foreign countries, the US, to take advantage of higher interest rates. This will increase the demand for US currency. The purchase of foreign-currency bonds leads to an increase of home currency money supply and results in a decrease in the exchange rate. The sterilized intervention is expected to have little effect on home interest rates because the money supply is expected to remain constant. As far as effecting interest rates nonsterilized intervention appears to be the better option. Chap 8 1.What is the relationship between the exchange rates and relative inflation levels of the two countries? How will this relationship affect Blades’ Thai revenue and costs given that the baht is freely floating? What is the net effect of this relationship on Blades? Thailand’s relative inflation rates have increased. This would cause the demand for baht currency to decline because exports have declined due to increasing prices. Exchange rate adjustments are critical to keeping relative purchasing power equal over time as inflation rate differentials fluctuate. When purchasing power is not equal consumers will move to cheaper alternatives. Since products are on a fixed price level they are not adjusted for Thailand’s inflation increases. There will be an increased demand for Blades exports by Thailand’s retailers and consumers because these products have not been adjusted for inflation. They are the cheaper alternative comparable domestic goods. According to purchasing power parity (PPP) equilibrium exchange rate will adjust by the same amount as the differential in inflation rates between two countries, however, there are often deviations from this theory. Thailand uses a free floating exchange rate where a currency’s value is able to fluctuate according to the foreign exchange market. Since Thailand is experiencing a higher level of inflation there is an increase in demand for foreign goods. Additionally, the demand for home goods is reduced. US currency will appreciate due to these market forces. The demand for Blades products will increase but the foreign currency purchasing these products has depreciated in value. This depreciation in Thailand’s currency causes a reduction in costs denominated in baht. US currency has appreciated, relatively. The net effect on Blades would be positive provided that the loss in the foreign currency’s value was offset by increased demand and reduced foreign costs. The magnitude of the cost/benefit ;however, is not clear. Chap 10 1.What type(s) of exposure (i.e., transaction, economic, or translation exposure) is Blades subject to? Why? Blades is subject to transaction exposure, the sensitivity of the firm’s contractual transactions in foreign currencies to exchange rate movements. The net cash flows need to be evaluated by each foreign transaction. First, cash inflows from the sale of goods and cash outflows from the purchase of components result in a positive cash flow. This cash flow is subject to a range of possible exchange rate fluctuations. Appreciation in the value of the foreign currency that caused a net positive cash inflow is viewed as favorable for the MNC. Japanese components imported and other foreign imports are also subject to exchange rate movements. Blades is also subject to economic exposure, the sensitivity of cash flows to exchange rate movements. Appreciation of a local currency would reduce cash inflows and outflows. Finally, Blades is subject to translational exposure. Components are imported from foreign subsidiaries, this could expose the MNC to different accounting practices biasin g cash flows relative to US accounting principles. 3.If Blades does not enter into the agreement with the British firm and continues to export to Thailand and import from Thailand and Japan, do you think the increased correlations between the Japanese yen and the Thai baht will increase or decrease Blades’ transaction exposure? If Japan was primarily used for export, as a result negative cash flows, this position would offset the positive net cash flow incurred by Thailand’s import and export. Since the currencies move in the same direction, a depreciation in currency would have a negative effect on positive cash flows and a favorable affect on negative cash flows. This interaction will help to offset exchange rate fluctuations and effectively reduce transaction exposure. On the other hand, if Blades has a positive net cash flow from the export and import of these highly correlated currencies, Japanese yen and Thai baht, Blades may be exposed to a relatively high level of exchange rate risk. This would increase transaction exposure. This result is due to the fact the currencies are positively correlated as a result the values of the currencies move in the same direction and by a similar amount. This would mean exchange rate effects would not be offset between the currencies if both currencies resulte d in positive cash inflows. 4.Do you think Blades should import components from Japan to reduce its net transaction exposure in the long run? Why or why not? Yes, as discussed above, components imported from Japan, resulting in a negative net cash flow (cash outflow), will help to offset the positive cash flow from exports to Thailand. Since the yen and baht are positively correlated the opposing direction of cash flows between these currencies will help to offset the net currencies fluctuation in value. This helps offset transaction exposure effects because payables and receivable interact in an inverse relationship toward exchange rate benefits.