Hedging Alternatives for THB Essay - 2200 Words

Hedging Alternatives for THB (Essay Sample) Content: Hedging alternatives for THBTransaction exposure has become one of the biggest challenges in the modern day international trade. This is because of the volatility of international currencies and the risk that the changes in the value of the currencies will result in a loss from trade receivables and/ or payables depending on the position of the trader (Karanjit 25). This has in effect led to emergency of different means of managing transaction exposure brought about by the uncertainty of the foreign exchange rates. Many international companies have now adopted different methods that suit their unique situations in the quest to manage the transaction exposure brought about by the currencies volatilities in value.In the case of Blades Corporation, there are different hedging methods available for it to explore. Ensuing is a discussion of the various hedging methods that Blades Corporation is able to employ in order to cushion itself from the transaction exposure it face s while trading with Entertainment products.Forward market hedge Sales THB 206,730,000.00  $ 6,822,090.00  Spot rate THB 206,730,000.00  $ 6,511,995.00  Forward rate 5% 206,730,000.00  $ 6,891,000.00  $ 344,550.00 20% 206,730,000.00  $ 6,470,649.00  $ 1,294,129.80 30% 206,730,000.00  $ 6,553,341.00  $ 1,966,002.30 25% 206,730,000.00  $ 6,615,360.00  $ 1,653,840.00 15% 206,730,000.00  $ 6,822,090.00  $ 1,023,313.50 5% 206,730,000.00  $ 6,925,455.00  $ 346,272.75  $ -  3 month spot rate  $ 6,628,108.35  Forward rate  $ 6,511,995.00  Difference  $ 116,113.35 From the above table, Blades Corporation may decide to enter into a forward contract to buy a tota l of $6,511,995 in three months time from the THB206,730,000.00 it expects to receive from entertainment Products. This cushions it from any potential loss in the value of the dollar in three months time when the receivables fall due. Blades then will have hedged against potential loss in the value of the dollar through incurring an extra $310,095.00 which is the difference between the current spot rate and the 3 months forward rate value of the receivable. However, from the probabilities given the expected spot rate after three months give a higher amount of returns since it results in $6,628,108.35 against a forward rate of $6,511,955.00Blades Corporation can also hedge against the payable that will fall due in three months time through buying THB in a 3-month forward contract now. The table below shows the amount of dollars that it commits itself to pay three months from now in order to hedge against the payable to Thailand after the three months have lapsed. Purchases THB 54,000,000.00  $ 1,782,000.00  Forward rate THB 54,000,000.00  $ 1,701,000.00  Spot rate 5% 54,000,000.00  $ 1,800,000.00  $ 90,000.00 20% 54,000,000.00  $ 1,690,200.00  $ 338,040.00 30% 54,000,000.00  $ 1,711,800.00  $ 513,540.00 25% 54,000,000.00  $ 1,728,000.00  $ 432,000.00 15% 54,000,000.00  $ 1,782,000.00  $ 267,300.00 5% 54,000,000.00  $ 1,809,000.00  $ 90,450.00  3 month spot rate  $ 1,731,330.00  Forward rate  $ 1,701,000.00  Difference  $ 30,330.00  - Using the above analysis, forward contracts hedging is not advisable since Blade may lose a total of $30,330.00.Money market hedgingThis is where a trader who expects to receive a c ertain amount of money at a future date borrows foreign currency, the trader buys the home currency and in spot rate and invests the home currency. If the trader expects to pay a certain amount in a foreign currency at a future date, then the trader borrows in home currency, buys foreign currency using the spot rate and invests in foreign currency.Blades Corporation may opt to enter into money market hedge. To do so, the corporation will borrow THB 204,662,700 at a rate of 4% p.a in Thailand. This is because at the interest rate of 4% the principle plus the interest to be paid after three months equals the amount of receivable from Thailand from the sales of 45,000 units of speedo. After borrowing at 4% in Thailand, Blades will then convert the currency into dollars using the spot rate and get $6,743,869.10. The amount obtained from the spot rate is then invested or deposited in the home country at an interest rate of 2.1%. Once the receivable from Entertainment Products is realized after the three months, blades the pays the ender the full amount plus principle. In doing so Blades earns an interest of 2.1% on the amount invested and after the three months it will receive a total of $6,835,590.92 which includes principle and interest on the money borrowed. In doing so the difference between the dollar value of the borrowed and the amount paid is a potential loss of $115,701.00. This is a better option than the forward contract where the trader incurs a potential loss of $116,113.35.In dealing with the payables, Blades will borrow the dollar amount equivalent to the present value of the obligation amount of THB54,000,000.00. Using the spot rate of USD 0.033, the company will borrow $1,768,635.00 which when translated into the foreign currency will equal to THB53,595,000. This amount is then deposited into the foreign account in Thailand and the interest gained after the three months when added to the principle invested equal the amount payable of THB54,000,000. 00. Using the money market hedging, the trader spends a total of 1,771,753.00 while using the forward contract hedging Blade will spend only $1,771,753. As a result it is advisable to use money market hedging when managing the transaction exposure from the payables.Hedging alternatives for GBPBlade Corporation has three alternative for hedging against the transaction exposure from trading with Jogs. These are forward contracts hedging, money markets hedging and options hedging. Using the Forward contracts blades will require to enter into a contract to sell 4 million pounds receivable at the end of the three months. The forward rate for this transaction is $1.59/ £. This assures Blades of $6,360,000 after three months making a potential loss of $40,000.00 since the spot rate is $1.6/ £ as the following table indicates.  forward Spot  £ 4,000,000.00   £ 4,000,000.00 Rate  £ 1.59 1.6  £ 6,360,000.00   £ 6,400,000.00  Differen ce - £ 40,000.00 The table below indicate the probability of the various exchange rates at spot after the three months and offers a benchmark on whether it is advisable to enter into a forward contract or not.Probability Rate amount  £Amount $5%  £ 1.55   £ 4,000,000.00  $ 310,000.00 20%  £ 1.57   £ 4,000,000.00  $ 1,256,000.00 30%  £ 1.58   £ 4,000,000.00  $ 1,896,000.00 25%  £ 1.59   £ 4,000,000.00  $ 1,590,000.00 15%  £ 1.60   £ 4,000,000.00  $ 960,000.00 5%  £ 1.62   £ 4,000,000.00  $ 324,000.00  Total  $ 6,336,000.00 Comparing the forward rate obtained above where Blade would receive a total of $6,360,000.00 against an expected $6,336,000 if the corporation decide not to hedge, it is advisable that the company enters into a forward contract which has a better payoff. Hedging using money marketsFor the amount of mon ey that Blade expects to receive from the UK in three months time, it is possible for the corporation to hedge using money market technique. To achieve this, Blade needs to borrow in pounds an amount equivalent to the present value of the receivable amount at the end of the three months. This using the borrowing rates in the UK of 2.0% per year, the firm needs to borrow  £3,980,000 which at the interest rate of 2.0% per year for 3 months will yield a total of  £4,000,000 being the sum of both the principle and the interest. The cash borrowed and converted into dollars adds up to $6,368,000. When invested at a return of 2.1% per year for three months, it yields $6,401,432 against a receivable of $6,336,000 if Blade opts not to hedge and a total of $6,360,000.00 when it hedges using forward contracts. This means that money market hedging offers a better option than forward contract and the policy of non-hedging.Hedging using Options contractsUnder options hedging, the firm that ha d a receivable buys foreign currency put. An option is a contract that gives the buyer the right but not the obligation to sell or buy a particular asset at a predetermined price on or before a specified future date (Hillman and Keim 78). Blade can therefore, decide to purchase put option for the amount receivable in pounds at the end of the three months. To do so, Blade will need to purchase 128 put options at GBP31,250. The option gives lade the right to exchange the 4million pounds receivable at an exchange rate of $1.57/ £ should the exchange rates be adverse. The option will however cost Blade $125,600.From the above analysis, it is clear th...