Merrill Case - Exchange Rate - UCR

Vicky HAN

Rocío PARDO DE DONLEBÚN Y RUESTA

Diego BARRIOS CARBALLÉS

Emilio HERNÁNDEZ

Alexis REVUE

What is the current situation ?What can we do ?What should we do ?

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Merrill Electronics Corporation (MEC) : Electrical and Electronics manufacturer ImporterImporter Japanese consumer electronics Personal Computer STFW and HDWR Distributor of Fuji Electronics

3Current Situation (1/3) – Merrill history

High volatilityvolatility of the Japanese Yen

Payment in 90 90 days days currency risk exposure

Most of the equipment imported from Japan (80%80%)

Japanese suppliers insisted on invoicing invoicing in Yen in Yen

4Current Situation (2/3) – Environment

9 month Loss due to Exchange Rate $ -309.700$ -309.700

ER Loss / Net Income : 36% Risk Exposure : ¥ Acc. Pay. +99%

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$ -531.200 $ +221.500

Current Situation (3/3) – Impacts

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A. Remain Unhedged

Lock-inLock-in methods

B. Forward C. Money Market D. Option

E. Future

The Problem – Exchange Rate Problem from IMPORTER’s perspective

CHARACTERISTICS Doing nothing

PROS You might savesave money

CONS Directly influenced by future spot rate You might loselose money… … You do not know until it happensYou do not know until it happens

7A - Unhedged (1/2)

8A - Unhedged (2/2) – Net Profit / Spot Rate

e¥/$,t = ¥126Saving = $20,064

e¥/$,t = ¥126Saving = $20,064

¥ APPRECIATION ¥ DEPRECIATION

e¥/$,t = ¥122Loss = $38,484

e¥/$,t = ¥122Loss = $38,484

CHARACTERISTICS Fixed Forward Rate

PROS No risk, fixed rate Easy to contract

CONS Can not benefit from market opportunities

9B - Forward (1/2)

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fwd¥/$ = ¥124.95Saving = $5,058fwd¥/$ = ¥124.95Saving = $5,058

B - Forward (2/2) – Net Profit / Spot Rate

¥ APPRECIATION ¥ DEPRECIATION

CHARACTERISTICS Short-term borrowing, lending,

buying and selling Maturities of one year or less Instruments: T bills, commercial

paper, bankers' acceptances, CD, etc.

PROS Less risks Easy to get into the money

market

CONS Can be more expensive Necessary to get a loan

11C – Money Market (1/2)

cash$

bb

ii

e¥/$,0

d0 d90

loan$

fixed plan¥

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b$ = 1.75% = 6%/4 + 0.25%i¥ = 0.8438% = 3.375% /4

Loss = $16,228

b$ = 1.75% = 6%/4 + 0.25%i¥ = 0.8438% = 3.375% /4

Loss = $16,228

¥ APPRECIATION ¥ DEPRECIATION

C – Money Market (2/2) – Net Profit / Spot Rate

CHARACTERISTICS Two parties, strike price, maturity date Call option

Buyer : rightright Seller : obligation obligation when seller strikes

The buyer pays a premium premium for this right.

PROS The buyer can choose choose Can be combined with other instruments The contract is not locked Unlimited profits Unlimited profits Limited loss Limited loss (premium)

CONS Cost of the premium

13D – Option (1/2)

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Call Rate = ¥125Premium = $0.00017

Loss = $32,472

Call Rate = ¥125Premium = $0.00017

Loss = $32,472

¥ APPRECIATION ¥ DEPRECIATION

D – Option (2/2) - Net Profit / Spot Rate

15E - Future (1/2)

CHARACTERISTICS Standardized contracts Maturity date Exchange rate Contract size Premium

PROS Fixed E/R when matures Low risk of losing money Possibility to sell it at market price

CONS Broker’s commission Expensive premium Requires attention due to the

speculation involved Cash available at fixed maturity date

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Future Size = ¥12.5Bftr¥/$ = ¥124.29

Premium = $1,500Loss = $31,572

Future Size = ¥12.5Bftr¥/$ = ¥124.29

Premium = $1,500Loss = $31,572¥ APPRECIATION ¥ D

E - Future (2/2) – Net Profit / Spot Rate

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18Recommendation 1/4 – What and when it’s cheaper ?

¥ APPRECIATION ¥ DEPRECIATION

19Recommendation 2/4 - Exchange Rate History

Appreciation ?Depreciation ?

??

Factors Affecting E/R

Relative Interest RatesRelative Inflation Rates

PPP Big Mac indexUS$ undervalued by 24% against the ¥

Long Term Depreciation of ¥ against $

Relative Income LevelsGovernment Controls

Japan is likely to stimulate domestic demand

Expectations Strong ¥ would solve Japanese trade surplus Weaker $ would boost US competitiveness

Appreciation of ¥ against $

20Recommendation 3/4 - What is the exchange rate trend ?

Trend of Exchange Rate:

Appreciation of ¥ against $e¥/$ < ¥ 124.60

Recommendation:

FORWARD Benefits:

No risk at all Saving between $5,058 & $7,217 Easy to manage

For all the transactions:Apply the same comparison methodConsider the money market

21Recommendation 4/4 - What do we recommend ?

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Vicky HAN

Rocío PARDO DE DONLEBÚN Y RUESTA

Diego BARRIOS CARBALLÉS

Emilio HERNÁNDEZ

Alexis REVUE