Merrill case final

Multinational Finance Management

‘The Merrill Case’

Presentation by: Yu Zhang, Juan Leon Sanchez, Francisco Magro Ruiz,

Hongfeng Wu and Hasan Soylemez

February 22, 2013

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Index

Introduction

Problems

Solutions and Options

Comparison

Conclusion and Recommendation

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Introduction

• Merrill Electronics Cooperation (MEC) was founded in 1950 by Thomas Merrill

• After his death, Patricia Merrill inherited the 75 % of the share capital together with her mother

• In 1984, MEC signed an agreement with Goldstone Corporation in Taiwan, which was a major producer of electronic devices

• In mid-1980’s, MEC entered the fast-growing market PC market which was becoming more and more competitive each day

• In 1989, it became a national distributor for Fuji Electronics

• Yen-dominated purchases exceeded $ 20 million during the past 12 months

• Due to growing volume in the market, further Yen purchases was foresaw

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Problems

• High volatility of the Japanese Yen

• The payment problem: 90-day currency risk exposure (60 days shipping + 30 days grace period of payment after delivery)

• Average of 6.1¥/$ difference for a 3-month period with the average spot rate of 130.83¥/$ (Exhibit 4)

• Most of the equipment were imported from Japan

• Further Yen purchases were foreseen

• Most of the Japanese suppliers insisted on invoicing in Yen

• More sensitive to currency risk than competitors

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Options

• No-hedge

• Lock-in exchange rate

• Forward contract hedge

• Money market hedge

• Yen futures hedge

• Options contract

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Options

Historical Data and Analysis

Scenarios

Pros and Cons

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Options

0 1 2 3 4 5 6 7 8 9 10 11 12 115

120

125

130

135

140 *Exchange Rate Yen/USD

• A trend of Yen appreciation against the USD with an average annual rate of +10%.

• High probability that the trend will prevail for the future.

What does the historical data show and imply?

*See Exhibit 4

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Options

SCENARIOS

Scenario 1

Spot Rate ¥/$ remains same

124.6 ¥/$

Scenario 2

Yen Depreciates by 3%

128.338 ¥/$

Scenario 3

Yen Appreciates by 3%

120.862 ¥/$

Assumptions: • Historical trend shows that the annual appreciation of

¥/$ was app. 10%• Therefore, appreciation/depreciation of ¥/$ would be

app. +/-3% for 3 months• No-hedge: Continue buying Yen at the spot market each

time a payment has to be made

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Options - No-hedge

SCENARIOS

Scenario 1


124.60 ¥/$

Scenario 2


128.34 ¥/$

Scenario 3


120.86 ¥/$

$1,805,778¥225 million

$1,753,183¥225 million

$1,861,627¥225 million

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Options - No-hedge

Pros Cons

If Yen depreciates, the company can gain from

lower cost of goods

If Yen appreciates, the company may suffer from higher cost of

goods

Costs almost nothing (No premiums, fees

etc.)

Exchange rates can not be precisely predicted

Easy to implement, no need for specialized

financial staff

Market conditions make it harder to put sound

exchange rate forecasts

Completely vulnerable to market volatilities

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Options - Forward Contract

Forward contracts are agreements between two parties which require delivery of one currency at a specified future date of a specified amount of another currency.

• Exchange rate fixed between the parties1st step

• Time

2nd step • Buy the

currency at the price set in the 1st step

3rd step

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BID ASK

Spot rate(Yen per USD)

124.60 124.70

Forward rate(Yen per USD)

124.95 125.10

BID: The rate at which bank sells YEN

ASK: The rate at which bank buys YEN

The company needs to buy YEN;

¥225 million on the forward market:

225,000,000 / 124.95 = $ 1,800,720

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SCENARIOS

Scenario 1


124.60 ¥/$

Scenario 2


128.34 ¥/$

Scenario 3


120.86 ¥/$

$1,805,778$1,800,720

$1,753,183$1,800,720

$1,861,627$1,800,720

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Pros Cons

No internal costsYou are responsible to fulfill the contract

and tied-up

Minimize the risk of the currency operations

You will be unable to benefit from any

positive movements in the foreign exchange rate

Amount and date adapted to individual

requirementsIt can’t be traded

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Options - Money Market Hedge

Merrill would buy the YEN at today’s spot market and place it in a YEN time deposit or another YEN asset until the due date.

Deposit Credit

90-days Euroyen interest rates 4.3125 % p.a.

4.4375% p.a.

90-days Eurodollar interest rates*

3.3750% p.a. 3.5000% p.a.

Merrill’s short term borrowing rate is 6.00% + 25 bps

Transactions:1-) The YEN amount needed to deposit in order to have 225M by October: 225,000,000 / (1+0.01078125) = ¥ 222,600,0932-) Borrow from the bank in USD (6.0025% / 4 = 1.500625%) 3-) Convert the USD to YEN as of today: ¥ 222,600,093 / 124.60 = $1,786,5184-) Time deposit the YEN until the payment date5-) Pay the bank back in USD, and the supplier in YEN;USD amount needed along with the interest: $ 1,786,518 * 1.01500625 = $ 1,813,327

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SCENARIOS

Scenario 1


124.60 ¥/$

Scenario 2


128.34 ¥/$

Scenario 3


120.86 ¥/$

$1,805,778$1,813,327

$1,753,183$1,813,327

$1,861,627$1,813,327

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Pros Cons

Highly profitability if enough cash available

High complexity of calculation

No exchange rate risk Volatility of money-markets

Generate profits if loan interest < deposit

interest

Dealing with Japanese financial market

Possibility of short term investments

Loan interest pose additional cost

No penalties for fast withdrawing

Opportunity costs may occur if USD appreciates

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Options - Yen Future Hedge

International Monetary Market (IMM) provided the data:

$ per ¥100 ¥ per $1

September yen futures (IMM) 0.8046 124.285

December yen futures (IMM) 0.8036 124.440

Other Data :

Standard Future size = ¥ 12,5 million per contract

Broker’s fee = $1,500 per contract

Total ¥225 million

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Calculations:

How much $ should pay for the futures contract?

¥225,000,000 / 124.440 = $1,808,100

How much futures contracts should be needed? ¥225,000,000 / 12,500,000 = 18 futures contracts

How much should we pay for the Broker’s Commission ? $1,500 * 18 contracts = $27,000

So, the total cost of future contracts including commission is: $1,808,100 + $27,000 = $1,835,100

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SCENARIOS

Scenario 1


124.60 ¥/$

Scenario 2


128.34 ¥/$

Scenario 3


120.86 ¥/$

$1,805,778$1,835,100

$1,753,183$1,835,100

$1,861,627$1,835,100

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Pros Cons

Standardized contracts

No tailoring of individual needs

Possibility of trading Broker commission

Safe method Margin account is required

Possibility to reduce exchange rate risks

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Options - Currency Option Contract

This contract gives the right but not the obligation to buy (call) or to sell (put) currency or some other asset within a specified

period and at a predetermined price.

Types of currency options:“European”-type options“American”-type options

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October yen call options (IMM)

$ per 100 ¥ ¥ per $

Strike price 0.800 125

Premium price 0.0170 5882.35

Provided yen amount

225 million ¥ 225 million ¥

CALCULATIONS:

- Buy call options = ¥225,000,000 x 0.008 = $1,800,000

- Premium cost = ¥225,000,000 x 0.00017 = $ 38,250

- Total cost = $1,800,000 + $ 38,250= $1,838,250

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SCENARIOS

Scenario 1


124.60 ¥/$

Scenario 2


128.34 ¥/$

Scenario 3


120.86 ¥/$

$1,805,778$1,838,250

$1,753,183$1,838,250

$1,861,627$1,838,250

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Pros Cons

Not obligatory All have an expiration date

High flexibility Pre-paid premiums and fees

Unexpected market conditions only leads to a loss of the premium

Buying out of the contract leads to a loss of the premium already paid

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Comparison

Options

Scenario 1Current Spot Rate Remains

the Same124.60 ¥/$

Scenario 2Yen

depreciates by -3%

128.34 ¥/$

Scenario 3Yen

appreciates by +3%

120.86 ¥/$

Do Nothing - +52,595 USD -55,849 USD

Forward -5,058 USD -47,537 USD +60,907 USD

Money Market Hedge

-7,548 USD -60,144 USD +48,301 USD

Futures -29,322 USD -81,917 USD +26,527 USD

Currency Options

- 32,472 USD -38,250 USD +23,377 USD

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Conclusion and Recommendation

1. Shall the trend of Yen appreciation against USD continue, the best hedging option is locking-in a forward rate agreement with the bank due to the potential gain compared to the other alternatives and easy format of implementation.

2. On the other hand, shall Yen depreciate against USD, then simply doing nothing would suffice and be the best hedging option.

3. Options contracts should also be considered since they can be not exercised if Yen depreciates against USD. In such a case, only the commission would be lost.

4. All in all, even the best option is highly dependent on the expected exchange rate and an accurate prediction can never be made.

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Thank you!

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Merrill case final