Question

1. Bobcat Company, U.S.-based manufacturer of industrial equipment, just purchased a Korean company that produces plastic nuts and bolts for heavy equipment. The purchase price was Won7,500 million. Won1,000 million has already been paid, and the remaining Won6,500 million is due in six months. The current spot rate is Won950/$, and the 6-month forward rate is Won975/$. The six-month Korean won interest rate is 8% per annum, the six-month US dollar rate is 6% per annum. Bobcat can invest at these interest rates, or borrow at 2% per annum above those rates. A six-month call option on won with a 1,000/$ strike rate has a 2.0% premium, while the six-month put option at the same strike rate has a 1.4% premium.

Bobcat can invest at the rates given above, or borrow at 2% per annum above those rates. Bobcat's weighted average cost of capital is 12%. Compare alternate ways that Bobcat might deal with its foreign exchange exposure. What do you recommend and why?

Assumptions		Values
Purchase price of Korean manufacturer, in Korean won		7,500,000,000
Less initial payment, in Korean won		(1,000,000,000)
Net settlement needed, in Korean won, in six months		6,500,000,000
Current spot rate (Won/$)		950
Six month forward rate (Won/$)		975
Bobcat's cost of capital (WACC)		12.00%
Options on Korean won:		Call Option		Put Option
Strike price, won		1,000.00		1,000.00
Option premium (percent)		2.000%		1.400%
		United States		Korea
Six-month investment (not borrowing) interest rate (per annum)		6.000%		8.000%
Borrowing premium of 2.000%		2.000%		2.000%
Six-month borrowing rate (per annum)		8.000%		10.000%

a. Refer to Instruction 10.1. If Bobcat decides to perform a money market (balance sheet) hedge, how many US dollars will in need at settlement in 6-months?

A. $6,587,947.

B.Won6,973,684.

C.Won6,578,947.

D.$6,973,684

b. Refer to Instruction 10.1. Bobcat chooses to hedge its transaction exposure in the forward market at the available forward rate. The required amount in dollars to pay off the transaction in 6 months will be:

A. $7,692,308.

B.$6,666,667.

C.$7,894,737.

D.$6,842,105.

2.

Brent Bush, CFO of a medical device manufacturer, BioTron Medical, Inc., was approached by a Japanese customer, Numata, with a proposal to pay cash (in yen) for its typical orders of ¥15,000,000 every other month if it were given a 2.0% discount. Numata's current terms are 30 days with no discounts. Using the following quotes and estimated cost of capital for Numata, Bush will compare the proposal with covering yen payments with forward contracts.
			Spot rate, ¥/$		¥111.40/$
			30-day forward rate, ¥/$		¥115.00/$
			90-day forward rate, ¥/$		¥116.40/$
180-day forward rate, ¥/$		¥117.20/$
Numata's WACC		10.000%
BioTron Medical's WACC		12.000%

How much (in present value terms) will BioTron receive in US$s if Numata is given NO discount and exchange rate risk is managed using the 30-day forward contract? (Hint: Only consider one payment of Yen15,000,000.)

A.Yen130,435.

B.$129,143.

C.$130,435

D.Yen129,143.

Answer 1

1 a)

With money market hedge, Bobcat borrows $ today for 6 months and converts them to Won today, and invests for 6 months in Won in such a way that Won 6500 million is available after 6 months

Amount in Won to be deposited today = Won 6500 million/ (1+0.08*6/12) = Won 6250 million

Amount of $ to be borrowed today = Won 6250 million/ ( Won 950/$) =$6.578947 million

Maturity amount of $ borrowing (at WACC) to be paid after 6 months

=6.578947 million * (1+0.12*6/12) =$6.973684 million or $6,973,684 (option D)

b) With forward market hedge, exchange rate of Won 975/$ will be fixed today

Hence, Dollars required after 6 months = Won 6500 million/ (Won 975/$) = $6,666,667 (option B)