International finance management Essay Example
COURSE TITLE: INTERNATIONAL FINANCE
For the case of 10,000 participants
The cost per student is 1,000 with an option premium of 5 percent
There are three types of risks associated with low volume participants (volume down/volume up) scenario. These risks include bottom line risk which is an adverse change in exchange rates which would increase cost base, competitive price risk and volume risk. If they do not edge then they are faced by bottom line risks. At a Forward rate of 1.22, Option premium of 5percent at 1.22 euro strike.
When the volume is 30,000 students, then the organization is forced to pay for 5,000 at the rate of 1.22 and a loss is realized of equivalent cost. When a rate of 1.01 they will be forced to pay more hence incurring cost, however, at a rate of 1.48 the organization saves up to 14.31 percent.
At rate of 1.01 they will not exercise the option because they must pay more in cost
At 100 percent option scenario
Total cost= (1,525,000+25,250,000)
They must pay more for in cost
Steady dollar at 1.22 with no hedge cost they must pay more on premium costs.
I recommend this policy, at weaker dollar rate 1.48, No Hedge Costs= 37,000,000. The option is viable.
Total Cost = 1.22*25,000,000+1,525,000=32,025,000 Windfall= Gain of $4,975,000. This will have a cost saving of up to 13.45%.
At sales volumes of 10,000 Future costs =30,500,000 and they will be forced to sell Euros 15,000,000 back at the spot rate. Weak USD at 1.48 saves up to 42.42% in costs.
Futures Cost= $30,645,000 for 25,000,000 Euro AIFS is forced to sell 15,000,000 Euro back at current spot rate. Total Loss in USD is the same but Windfall is accentuated. Pay up to 53.42% more in costs.
Sales volumes of 3,000 students, they must pay for 5000 students at spot rate. They are stuck paying the Premium of $1,525,000. The Dollar amount gained and lost is the same as the expected volume, Windfall percent is accentuated for low sales and minimized for high sales.
Types of hedging policies
These are commonly financial and physical policies by a firm to help in managing the risks business is exposed to. There are three types of hedging policies namely; no hedging, hedging with forward contracts and hedging with options.
No Hedging- An investor may decide not to hedge foreign currency investments because of they might not understand the risks the portfolio ids exposed to, the hedging costs are very high and an investor may think any currency fluctuation will eventually be reversed.
Hedging with a forward- these are contract agreements made today to deliver an asset in the future at a predetermined price. There is no exchange of money before maturity and these types of contracts are traded over the counter. There are certain buyer seller obligations whereby the seller should deliver the asset and accept the predetermine price on maturity while the buyer is expected to accept the asset and pay the agreed upon price on maturity. In our case, the gains are higher in the money since there is no exchange before maturity. Forward contract help companies to fix interest rates today for the future and manage commodity price risk
Hedging with options- This policy is usually achieved by selling call option and buying put options. As an organization sells calls they are bringing in money (in the money) against exchange rates, which will cushion the money incase exchange rates fluctuate downwards (the profits from the call offsets the loss as a result value of money lost). This gives companies right to purchase when exchange rats are favorable. Options gives rights not obligation since when there is an adverse movement in rates then the holder can allow the option to lapse. Buying puts cushions the investments incase disaster happens. In Case disaster doesn’t strike, then the money is lost but the investment in puts is worthwhile since it saves an investor from potential loss.
Cross hedging- In cases whereby there is no exact replication of options/forward markets for an asset, then cross hedging can be used. For example if a company wants to hedge, their jet fuel but the hedging instruments are not available in the market then the company might decide to use crude oil futures contracts.
Desai,Desain &Sjoman, 2007 Hedging currency Risk at AIFS
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