transacton hedging euro/dollars

transacton hedging euro/dollars

Hey, I Just Sold a
Ton of Tractors!”

You
are the new CFO of Agri-Drone, a manufacturer of a very innovative set of
agricultural machines that operate without a driver. By using a combination of
computerized mapping augmented with precise GPS links and software, the
machines are capable of operating 24 hours a day, with refueling being the only
interruption. The agribusiness market is buzzing about them.

It’s Thursday
morning, and you see Jim, one of your top-performing salespersons, sprint down
the hall to tell his boss, the VP of Sales, that he just shook hands on a deal
to sell 2O tractors priced at $30,000 each and also 10 combines that sell for
$50,000 each. This $1.1 million order is the biggest in Agri-Drone’s short
history. Not to mention, it was the company’s first overseas sale. Your quick
mental math tells you that Agri-Drone’s cost of goods sold on this deal will be
$715,000, and a full allocation of operating costs would total another $220,000
of costs against the sale.

“Not bad,” you
think to yourself.

You join Jim and
Lois, VP of sales, as Jim is explaining that the customer is an immense farming
co-op in France, and the terms of the transaction are for Agri-Drone to be paid
in Euros upon delivery, which is promised for six months from today. Jim goes
on to say that the French customer suggested a conversion rate for the Euros,
which Jim admits he has agreed to.

“Excuse me,” you exclaim, “What
exchange rate did you actually agree to?”

“We agreed to 1.35.
It seemed to make the customer happy. Plus, I remember seeing on the Travel
Channel that recent conversion rates were about 1.3-something-or -other, so
that sounded good to me.”

“Actually, it’s closer to 1.30 today.”

“Hey, that’s close enough, right?”

You just shake
your head.

“Here’s the deal you
have to live with”

News of the huge order gets to Stephanie
Majors, your CEO, pretty quickly, and she wants to know the details. Your first
objective is to show her a side-by-side comparison assuming standard pricing
versus the contract pricing as converted into today’s USD.

Problem 1

Assuming
the EUR/USD exchange ratio is 1.30 today, what do you show the CEO? Demonstrate
you calculations below. The space expands
as you type.

“Here’s what
happens if we do nothing else…”

As your meeting with Stephanie continues,
you want to demonstrate what happens to the deal’s profitability if, in six
months, the EUR/USD exchange ratio ends up actually being 1.25, 1.30 and 1.35.

Problem 2

What
is the range of actual profit indicated using these exchange rate estimates? Please
demonstrate.

“…And here’s what
happens if we do something”

Just as you expect, Stephanie begins to
show concern, and you tell her there’s a simple way to protect the Company from
additional currency risk between now and six months from now.

Assume
the following facts:

Current EUR/USD spot rate –		1.30
6 mo. forward contract pricing		-0.0100
Call strike 1.3000 premium 2%
Put strike 1.3000 premium 2%

Problem 3

Based
on these facts, what would you recommend doing?

Problem 4

For
the method chosen, show the CEO what the revenues and profitability would be
assuming the EUR/USD exchange rate actually turned out to be 1.25, 1.30 and
1.35 in six months. Demonstrate your calculations.

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