Finance Education and Learning

Finance 453: Financial Theory and Analysis Autumn Quarter, 2004 Professor William D. Bradford Dozier Corporation 1. What are the actions available to Dozier concerning the exposure of the 1,057,000 pounds? Look Below 2. Which of these do you recommend? Why? 3. How should Dozier handle future bids on foreign projects so as to reflect foreign exchange risk ex ante rather than ex post? In the A case, Rothschild can hedge Dozier's exchange risk by either engaging in a forward contract (that is, selling pounds forward 90 days), or by borrowing pounds today, converting to dollars, and paying off the pound loan when the payment from the contract is received in 90 days. Fill in the numbers where there are question marks, in order to compare the profit of the alternatives. A. Forward Contract: l,057,500 pounds (balance due) @ 1.4198 = $1,501,438.50 + 117,500 pounds (deposit) @1.4370 = $168,847.50 ___________ = Total Revenue from the contract in dollars $1,670,286 Less costs $1,642,783 = Profit from transaction $27503 (1.6%) What about opportunity cost of investing at 8% B. Spot Hedge (Borrow pounds and get dollars now) Borrow 1,019,277 pounds @ 15% 90 days interest = 38,223 pounds Due on 4/14: 1,019,277 + 38,223 = 1,057,500 pounds Convert 1,019,277 today @ 1.4370 = $1,464,701.049 + Invest @ 8.0% (this is to be discussed) = $29,294 + 117,500 pounds (deposit)@1.4370 = $168,847.50 _________ = Total Revenue $1,662,842.549 Less costs $1,642,783 = Profit from transaction $20,059.549 (1.2%) C. Put Strategy The strategy discussed in Case B is to buy a put contract. The March put with a strike price of 1.45 is quoted at 4.4 cents per unit. At this price, the option will cost Dozier: .044 X 12,500 units per contract = $550 per contract or $550 X 85 = $46,750 for 85 contracts If in March the pound is lower than 1.45, this option will be exercised and Dozier will receive 1,057,500 pounds X $1.45 = 1,533,375 Less the premium 46,750 The premium = the option's cost = 1,486,625 + 117,500 pounds (deposit)@1.4370 = $168,847.50 Total Revenue = $1,655,472.5 Less Costs $1,642,783 = Profit from Transaction $12,689 minimum, unlimited potential gain if British pound begins to gain value on dollar.