Curtis Inc. is a U.S. manufacturer of heavy construction equipment used in the c
ID: 2731997 • Letter: C
Question
Curtis Inc. is a U.S. manufacturer of heavy construction equipment used in the construction of deep water ports and heavy lift capacity airports. Curtis is headquartered in Michigan, and has just received an order from a Pakistani Construction Company not known to you or to Curtis. The order is for two of your largest earth movers with the total sale price of e30.0 million euros. The Pakistani company requires Curtis to ship upon completion of manufacture and will pay the e30.0 million to you six months from shipment.
Global Financing (a Commercial Bank of which you are President and Chief Lender) is the international financier hired to put this financial transaction together and make it happen, (so don't make this a career limiting opportunity)!
Cost of funds is 4.75% (LIBOR)
Confirmation fees are 65 basis points
Negotiation fees are 12 basis points
Discount Commission is 30 basis points
Spot euro is $1.4950
90 day euro is $1.4975
180 day euro is $1.5000
Banker's Acceptance rates are 4.96%
Issues to consider:
The Pakistani's cannot pay for 180 days from shipment
Curtis wants it's money as soon as shipment is made
1. What are the many different ways you can make money from this transaction without taking any undue risk
2. How would you cover yourself for Pakistani risk
3. What other risks do you have (financial and otherwise), explain how to mitigate
Explanation / Answer
Ans;
a)
Ways to make money without any risk:
Supply the goods under letter of credit guaranteed by home country bank
Supply the goods under LC and factor the receivables
Supply the goods subject to credit guarantee from banker
Forward cover against currency risk
b)
Cover against pakistani risk:
Supply the goods under LC guaranteed by home country bank
c)
Other risk:
If goods is supplied CIF then risk of transit loss, can be mitigated through proper insurance policy
Currency fluctuations, can be mitigated through forward cover
Equilibrium
Spot rate
1.495
180 days forward rate
1.5
Interest rate parity
Forward rate = spot rate*(1+interest rate of other country )/(1+interest rate of home country interest rate)
Calculating UK interest rate by applying interest rate parity (1.495*1.0475)/1.50 - 1
2.03%
Accordingly if UK interest rates are 4.06% then Euro and dollar price will be in equilibrium else it will not be.
d)
Money to be received:
Gross sales value
300,00,000.00
Euro
Confirmation fee (30000000*.65%)
1,95,000.00
Negotiation fee (30000000*.12%)
36,000.00
Discount commission (30000000*.30%)
90,000.00
Acceptance rate (30000000*4.96%*180/360)
7,44,000.00
Cost of funds (30000000*4.75%*180/360)
7,12,500.00
Net money received
282,22,500.00
Net money dollar
421,92,637.50
USD
Yield
94.08%
(42192637 / 30000000*1.495)
e)
Investment instrument:
Receivable created out of this sales transaction can be factored and it will create a new financial instrument
This will be a revenue opportunity and will provide immediate cash to the seller and will avoid exchange risk as well
Amount to be received will be gross receivables reduced by factoring cost
Assuming factoring cost is equivalent to cost of funds, amount will be calculated as per below:
Gross receivables
300,00,000.00
Euro
Gross receivables
448,50,000.00
USD
Less: Factoring cost (44850000*4.75%*180/360)
10,65,187.50
USD
Net amount received
437,84,812.50
USD
f)
Foreign exchange risk elimination:
Taking forward cover
Cover will be taken on the date of transaction
Amount to be received under forward cover and eliminating currency risk
Gross receivables
300,00,000.00
Euro
180 days forward rate
1.50
Receivables fixed in USD value without any currency risk
450,00,000.00
USD
g)
Instrument to ensure performance of both the parties:
Performance LC can be used as a tool to ensure performance of both the parties
It will be initiated by buyer and will be sent to seller through seller's home country bank and it will obligate the seller to ship the goods at agreed date and will ensure payment to seller at agreed date.
a)
Ways to make money without any risk:
Supply the goods under letter of credit guaranteed by home country bank
Supply the goods under LC and factor the receivables
Supply the goods subject to credit guarantee from banker
Forward cover against currency risk
b)
Cover against pakistani risk:
Supply the goods under LC guaranteed by home country bank
c)
Other risk:
If goods is supplied CIF then risk of transit loss, can be mitigated through proper insurance policy
Currency fluctuations, can be mitigated through forward cover
Equilibrium
Spot rate
1.495
180 days forward rate
1.5
Interest rate parity
Forward rate = spot rate*(1+interest rate of other country )/(1+interest rate of home country interest rate)
Calculating UK interest rate by applying interest rate parity (1.495*1.0475)/1.50 - 1
2.03%
Accordingly if UK interest rates are 4.06% then Euro and dollar price will be in equilibrium else it will not be.
d)
Money to be received:
Gross sales value
300,00,000.00
Euro
Confirmation fee (30000000*.65%)
1,95,000.00
Negotiation fee (30000000*.12%)
36,000.00
Discount commission (30000000*.30%)
90,000.00
Acceptance rate (30000000*4.96%*180/360)
7,44,000.00
Cost of funds (30000000*4.75%*180/360)
7,12,500.00
Net money received
282,22,500.00
Net money dollar
421,92,637.50
USD
Yield
94.08%
(42192637 / 30000000*1.495)
e)
Investment instrument:
Receivable created out of this sales transaction can be factored and it will create a new financial instrument
This will be a revenue opportunity and will provide immediate cash to the seller and will avoid exchange risk as well
Amount to be received will be gross receivables reduced by factoring cost
Assuming factoring cost is equivalent to cost of funds, amount will be calculated as per below:
Gross receivables
300,00,000.00
Euro
Gross receivables
448,50,000.00
USD
Less: Factoring cost (44850000*4.75%*180/360)
10,65,187.50
USD
Net amount received
437,84,812.50
USD
f)
Foreign exchange risk elimination:
Taking forward cover
Cover will be taken on the date of transaction
Amount to be received under forward cover and eliminating currency risk
Gross receivables
300,00,000.00
Euro
180 days forward rate
1.50
Receivables fixed in USD value without any currency risk
450,00,000.00
USD
g)
Instrument to ensure performance of both the parties:
Performance LC can be used as a tool to ensure performance of both the parties
It will be initiated by buyer and will be sent to seller through seller's home country bank and it will obligate the seller to ship the goods at agreed date and will ensure payment to seller at agreed date.
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