1. If the spot rate for the Won is 800 won equals 1 US $, and the annual interes
ID: 1186343 • Letter: 1
Question
1. If the spot rate for the Won is 800 won equals 1 US $, and the annual interest rate on
fixed rate one-year deposits of won is 9% and for US$ is 3%, what is the one-year
forward rate for one won in terms of dollars? Assuming the same interest rates, what is
the 8-month forward rate for one dollar in terms of won? Is this an indirect or a direct
rate? If the forward rate is an accurate predictor of exchange rates, in this case will the
won get stronger or weaker against the dollar? What does this indicate about inflation
expectations in Korea compared to the US?
2. On January 3d, 2007, Daimler-Chrysler expects to ship 10,000 cars from its Hyundai
affiliated plant in Korea to the US, which it will sell through its US dealers on 240-day
terms at $10,000 each. So Daimler-Chrysler will receive payment from its dealers on
August 30, 2007. Assuming that Daimler-Chrysler group needs to cover its expenses in
Korea and thus wants to hedge its won exposure using a forward contract with a US bank
in Korea, what is the minimum amount of won they should receive on August 30th, 2007
given the eight month forward rate for one US dollar in terms of won that you calculated
in problem one? What is one other way they might they hedge their won/dollar exposure?
3. a) While market-based hedging instruments can be used to offset or counter
uncertainties in interest rates and exchange rates as they impact the income statement,
balance sheet hedges require a different approach. Assume you are the CFO of Toyota
trying to offset the balance sheet risks associated with Toyotas $4.5 billion investment in
Georgetown Kentucky. Please explain how this risk would be offset by a combination of
a 15-year Euro Dollar Bond with equal repayments in the last five years and a floating
rate 10 year syndicated Euro-Dollar bank loan combined with an interest rate swap.
Assume a fifteen-year straight-line amortization of the new Georgetown facility.
b) Look at the JAL FX loss scenario in the Additional Text Readings where JAL lost as
much or more in FX than the $800 million value of the planes it was purchasing. Then
calculate JALs cost if it had used a different type of hedge, borrowing US $ to buy US
government bonds that it then cashed as each plane was purchased. Generally one can
borrow up to 95% of the value of US government bonds with the borrowing cost
normally about .25% or 25 basis points above the yield on the bonds. Assume that the
yield on the bonds is 8% and that they borrow for the full 10 years noted in the case.
4. Look in the paper and give the direct and indirect quotes for the Euro, the Japanese
Yen, the British pound, the Swiss Franc, and the Hong Kong Dollar.
5.a) Microsoft, whose global sales are generally dollar denominated, finds it has excess
cash of $750,000,000, which it can invest for up to three years. It has determined that its
best options are either a three-year Euro-dollar ($) deposit paying 4.5% or a three-year
Euro denominated deposit paying 5.5% since it expects the Euro to depreciate 1% per
annum against the dollar over the next three years. Using cash flow analysis, determine in
which currency Microsoft should invest. Be sure to show your complete calculations of
the annual return and conversion of Euro back to dollars at the end of the three-year term.
Assume that the annual interest amount is reinvested, i.e. compounds, at the same annual
interest rates. Would your answer change if Microsoft revised its outlook for the Euro to
depreciate 1.25% per year?
b) British Oxygen whose global sales are generally dollar denominated needs to borrow
$50,000,000 for working capital and intends using a 5-year multi-currency revolving
credit. It can borrow in US$ at 8.5% p.a. or in SFr at 5.5% p.a. However, it expects the
SFr to appreciate on average 4% p.a. over the next five years. Using a cash-flow analysis
determine in which currency BOC should borrow. Would your answer change if BOC
could issue SFr commercial paper supported by the revolving credit at 3.5%?
Explanation / Answer
a) Forward in US terms =F$/FC = S$/FC (1 + ARIUS x n/360)/(1 + ARIFC x n/360)
b) In European terms =FFC/$ = SFC/$ (1 + ARIFC x n/360)/(1 + ARIUS x n/360)
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