Problem 10.2

The main methods that Bobcat can deal with foreign exchange exposure to managing foreign exchange risk are: Using a Forward exchange contract to lock in the agreed exchange rate of Won1,175/$ until the six month period comes to pass. As a result, Bobcat Company would buy the company at the rate of Won1,175 that was agreed upon in the forward rate agreement.This would protect Bobcat from adverse shifts in exchange rates during the six months. However, Bobcat will be locked into the contract price of Won 1,175/$, even when the rates change at the end of the six months in its favor. However, if the exchange rate remains the same, Bobcat would stand to gain a profit of Won65/$ based on the current spot rate of Won1,110/$.

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Bobcat can also use the foreign currency options to buy Korean currency under an agreement with its bank that gives the company the right but not the obligation to undertake the transfer of the remaining Won6,500 at the end of the six months at the agreed Korean currency rate of 4%p.a. This would protect Bobcat in case the U.S. decreases in value when compared to the Korean Won at the end of the six months. However, if the dollar strengthens against the Won, Bobcat has the option to abandon the choice and use the spot price of the dollar instead. The company can also enter into a forward exchange contract to receive payment in the form of U.S. dollars at the agreed rate of 16% per annum at the end of the period. This would hedge the company against foreign exchange risks by ensuring that Bobcat will receive payment at the agreed rate despite fluctuations in the foreign exchange rates that may occur.

I would recommend that Bobcat Company uses the Foreign currency exchange option to enter into a call option of a Won1,200/$ strike rate at a 3% premium to receive the payment in the Korean Won interest rate. This is because this option will protect the Bobcat Company from a decrease in value of the U.S. but allow the company to benefit from the increase in the value of the dollar against the Korean Won.

Problem 10.4: A hedging strategy can protect P&G from losing 8.5 million Japanese Yen payables for toiletries. It will minimize the loss if it occurs to a known value. Various hedging strategies could be used by P&G to protect its payables such as the use of Forwarding Contracts, Future Contracts, Swaps, Option contracts, and insurance hedging. However, Risk Hedging with Option contracts is not possible since options are currently not available in Indian Rupees. Based on the information provided in 14.2, I would recommend that P&G uses Commodity Futures contracts as a hedging strategy.

P& G can buy a futures contract from the Japanese company to purchase the toiletries at the current spot rate of YEN120.6/$, at the end of the 180 days before making the purchase. This will ensure that P&G protects itself from a future rise price of toiletries in the 180 days short term period as it would obligate the Japanese company to sell the toiletries to P&G at the current spot rate of YEN120.6/$. The company will have benefited from the contract by buying the toiletries at a lower price than the market price then. Better still, if there is a rise in prices of toiletries by the end of the period and the company does not need the toiletries, P& G can sell the contract before the expiry of the 180 days, therefore, making a profit.