To do business in India, with its underdeveloped capital markets

To do business in India, with its underdeveloped capital markets

Subject: Business    / Finance
Question
1. (10 points) To do business in India, with its underdeveloped capital markets, some

companies accept payment terms on payables as long as 180 days on a regular basis.

Assume that your company wants to hedge an 11.5 million Japanese yen payable and convert

it into rupees (Rs). Because the currency is so small in world markets, you will have to

calculate your own cross rate from the two rates provided. Also, foreign currency options

are not available on the Indian rupee. Instead, an Indian currency agent is available who will

lock in the current spot exchange rate for a 4.85% fee (payable up front, so that it functions

much like an option, just locked in). To clarify, you pay the agent a fee TODAY and that

agent guarantees that you will be able to get the current spot rate 180 days from now. Given

the following exchange rate and interest rate data, calculate potential choices and

recommend a hedging strategy.

Spot rate, yen/dollar ¥120.60/$ 180-day rupee investment rate 8.00%

Spot rate, rupees/dollar Rs47.75/$ 180-day yen investment rate 1.50%

180-day forward rate, yen/rupee ¥2.4000/Rs Cost of capital 12.00%

Expected spot rate in 180 days ¥2.6000/Rs

*Notice: Throughout this homework, the given rates are annualized. So a rate that is labeled as a

180-day rate is actually the annualized amount for a 180-day cash flow and still needs to be

divided by 2 to be used appropriately. This may seem confusing but it is the standard market

practice. If in doubt, ask!

2. (10 points) Assume that a company just purchased a Korean company. The purchase price

was Won 7,030,000,000, due in 6 months. The current spot rate is Won 1,200/$, and the 6-

month forward rate is Won 1,260/$. Caterpillar has the following investment opportunities

or it can borrow at 2% per annum above these rates (add 2% to all rates in the table to get

borrowing rates). The company’s WACC is 10%. Compare alternative hedging strategies

for the payable. What do you recommend and why?

6-month Korean interest rate 16% p.a.

6-month U.S. interest rate 4% p.a.

6-month call option on Korean won at W1,200/$ 3% premium

6-month put option on Korean won at W1,200/$ 2.4% premium

3. (10 points) A company has a receivable of ¥20,000,000 due in three months. The following

rates are available in the market:

Spot: ¥118.255/$

Three-month forward: ¥116.830/$

Three-month U.S. rate: 4.9375% p.a.

Three-month Japan rate: 0.09375% p.a.

(Borrowing rates are 2% higher.)

WACC: 16%

Call option with exercise of ¥118.00/$ has a 1% premium

Put option with exercise of ¥118.00/$ has a 3% premium

a. Analyze the various hedges available and recommend a hedging strategy.

b. What is the break-even rate that would cause the money market to be equivalent to the

forward?