Curtis Inc. is a U.S. manufacturer of heavy construction equipment used in the 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. Is the euro and the dollar at equilibrium? prove that it is or isn't
2. How much would you make on the total transaction in dollar and yield terms
3. Are there any possible investment instruments that can be created out of this transaction, is this also a revenue opportunity?, If so how much.

Explanation / Answer

The demand–supply model of exchange rate determination implies that the equilibrium exchange rate changes when the factors that affect the demand and supply conditions change. If you want to graph the dollar market, the quantity on the x-axis must be the quantity of dollars in the market. Therefore, the price indicated by the y-axis must be the price of dollars in another currency (in this example, the euro). In other words, the exchange rate has to be defined as the euro–dollar exchange rate. Consequently, the demand and supply curves indicate the demand for and supply of dollars. The figure shows the initial equilibrium exchange rate as €0.89 per dollar. Factors that affect demand and supply Ceteris paribus conditions are associated with the demand and supply of dollars. These conditions are related to the macroeconomic fundamentals of two countries represented in the exchange rate. Because the example exchange rate is the euro–dollar rate, the following variables may change in the U.S. or the Euro-zone, which then have an effect on the euro–dollar exchange rate: Inflation rate Growth rate Interest rate Government restrictions In the demand–supply model, these factors are divided into two areas based on how they affect exchange rates. Inflation rate and growth rate are considered trade-related factors. When you apply the changes in one of these factors to exchange rates, you think about the trade between the U.S. and the Euro-zone. The interest rate, on the other hand, is a portfolio flow–related factor. It means that when one of the country’s interest rate changes, you think about how this change affects the attractiveness of dollar- and euro-denominated securities to American and European investors. Government restrictions can be related to both trade flows and portfolio flows, depending on the nature of these restrictions. Note that the changes in inflation, growth, and interest rates, as well as government restrictions, don’t have to be actual changes that you are observing right now. If market participants have expectations regarding these changes, they will act on them now, producing the same results as if these changes were actually happening.

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