Hedging alternatives for THB
Transaction 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 faces while trading with Entertainment products.
Forward market hedge
From the above table, Blades Corporation may decide to enter into a forward contract to buy a total 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 $6,511,955.00
Blades 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.
Using the above analysis, forward contracts hedging is not advisable since Blade may lose a total of $30,330.00.
Money market hedging
This is where a trader who expects to receive a certain 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 GBP
Blade 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.
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.
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 markets
For the amount of money 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 contracts
Under options hedging, the firm that had 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 that money market hedging is the best of the three hedging techniques available to Blade Corporation. It even overrides the option of non-hedging since the payoff is superior with money market hedging than the weighted average expected spot rate at the end of the three month.
Generally, it is easier for Blades to hedge its inflows than its outflows. The main reason for this is that the outflows that Blade is expecting to occur in the future are riskier than the inflows expected. This is because the payables are subject to two uncertainties. These uncertainty are the uncertain future exchange rate, and the amount of money in foreign currency which arise from changes in the prices in the market.
The fact that the Blade has trading contracts with the international company that buys its products, it is almost certain that the amount of invoice in the foreign currency will be received and hence, its only concern will be to deal with the future exchange rates which it can effectively hedge. When compared to the inflows, where the company only deals with the uncertain future exchange rate, it becomes easier for Blade to hedge on the inflows than the outflows.
The need to over-hedge
None of the available hedging options will require the company to over-hedge. Over-hedging mainly arises when the option prices do not provide a trader with the exact amount options to buy when the trader is seeking to purchase options for the entire amount of receivable or payable. In this case, with the option price set at GBP31,250 per put, the entire amount of receivable could be exhaustively hedged buy purchasing 128 put options.
The Exporting arrangements that Blade has for both Thai and British customers would net need over-hedging when using money markets. This is because company has fixed sale contracts with the customers and there is not foreseeable adverse change in the foreign exchange over the ninety day period.
The need to modify the timing of Thai imports
One thing that Blades could do is to ensure it has bought from Thailand enough materials which are denominated in THB to cover all the inflows anticipated for the period. Since it anticipates to receive THB 206,730,000 in the following quarter, it can in turn decide to purchase inputs worth the same amount from Thai suppliers.
This will mean that instead of receiving THB 206,730,000, it can decide to instruct the Entertainment to pay the Thai suppliers all that amount of money and in turn have the suppliers deliver the inventory worth of the THB 206,730,000 which is 68,910 pairs. The advantage of this arrangement is that Blade successfully manages all the transaction exposure for the coming quarter. However, the company is left with high inventory levels and the transaction exposure in the subsequent periods will be higher than planned for.
In order to rearrange its payment practices, the company could ensure that it does not pay its debts 60 days in advance as it is currently doing. Blades could in effect, employ some exposure management techniques such as lagging where it expects the dollar value in relation to the THB to appreciate in values. In so doing, it will effectively incur less amount of dollars in paying for the supplies. The tradeoff is that Blades will be always dealing with the exposure on a regular basis and therefore, it will need to ensure that it hedges against the exposure more often.
Other long-term hedging techniques available to Blades
Blades could use swap currencies for long-term hedge where it could have arrangements with other firms in Thailand who would offer to pay Blades obligations in THB and/ or GBP while it in turn, settled their obligations denominated in dollars. The advantage of swap deals is that the foreign rate exchange risk is almost eliminated since there is not actual exchange transaction.
The challenge in this however, is that it would be hard to find companies or other traders willing and able to enter into swap deals mainly because of the different payment agreements which such companies have entered in. For the future business transactions Blades has with suppliers, it can enter into long-term forward contracts with for the amounts that it expects to receive from the customers. The other useful hedging technique is parallel loans.
This is where a company enter into an agreement with another company which whose subsidiary is domiciled in the home country of Blades. What ensues then, is an agreement is reached where Blade would lend the subsidiary of the foreign company an amount of money that the parent could have lent it thus incurring foreign exchange transaction risk, then in turn the foreign Parent company would lend to the foreign Blades’ subsidiary and have the two debt instruments settled by a way of an exchange rate agreement. I doing this, both the foreign parent and Blade get cushioned from any transaction exposure that could result from foreign exchange risk.
Works Cited
Hillman, J. and D. Keim. “Shareholder Value, Stakeholder Management, and Social Issues: What’s the Bottom Line?” Strategic Management Journal (2001): 125-139. 5. Print.
Karanjit, Singh. “Risk Management Hedging Commodity Exposure.” Wharton Research Scholars Journal (2004): 1-30. Print.