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Jason Cowne Kazuo Shirai Yen- nhi Do Julie Nguyen Chatree Jirakranjanavanit FIN 570 Dr. Greco July 6, 2009. Westwood Plastics Inc. Foreign Currency Risk Hedging Strategies. Outline. Economic Outlook Company/Case Background Products Industry Define the issue Transaction Risk - PowerPoint PPT Presentation
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Westwood Plastics Inc.Foreign Currency Risk Hedging Strategies
Jason CowneKazuo Shirai
Yen-nhi DoJulie Nguyen
Chatree Jirakranjanavanit
FIN 570 Dr. Greco
July 6, 2009
Outline• Economic Outlook • Company/Case Background
a. Productsb. Industry
• Define the issuea. Transaction Risk
• Analyze the case dataa. Basic Issuesb. Immediate Issuesc. Cause/Effect Diagramd. Critical Exchange Ratee. Exchange Rate Trends
• Generate alternatives• Select decision criteria• Analyze & evaluate alternatives• Conclusions
Case Data Analysis -Economic Outlook
Year 2005 Year 2006 Year 2007 Year 2008
Real GDP Growth CAD % 2.4 2.9 2.7 2.7
Real GDP Growth EUR % 2.3 3.3 2.5 2.2
Inflation CPI CAD % 3.4 2.5 3.1 2.4
Inflation CPI EUR % 2.0 1.8 1.9 2.0
Unemployment CAD % of labor force 7.0 6.8 6.4 6.0
Unemployment EUR % of labor force 6.7 7.5 6.9 6.6
CAD Long-term interest rates 4.1 4.2 4.3 4.1
EUR Long-term interest rates 4.3 3.8 4.2 4.3
Source: CIA World Factbook
Company Background
• Westwood Plastics– Core competency – Manufacture & sales of
proprietary plastic products in Canadian marketplace.
• License Agreement with Schalle Industry (Cologne, Germany)– Exclusive manufacturing and distribution rights to
Cryolac
Case Background
Westwood Plastics
Canadian Bank
Loan
Schalle Industrie (AG)
Mfg. Cryolac
Payment
Payment is a note (9.1%, n = 10)• Financing from two sources: Schalle & bank• Revenue is in CAD• Expenses is in EUR•The right to manufacture & distribute premium product, Cryolac
Company Background - Cryolac Products
Dough BoxWhite Cryolac Plastic
ABS
Plastic manufacturing processes: 1. Injection Molding II. Extrusion Molding
Cryolac is a specialized proprietary plastic
Company Background -Plastic Industry
• Over 3,400 companies• Employing 113,000 workers
• $33 billion Canadian dollars in Total Revenues
• 85% of plastics exports are bound for the U.S.
• Lowest production costs for the plastics sector among G7 countries
Define the Issue
• Time frame: March 01, 2006– Revenues are in CAD– Expenses are in EUR
• Currency market is highly volatile• Effects of depreciating CAD currency
– Pay more EUR – Understand effects of income & cash flows
(Projected fiscal 2007 results)
Define the Issue
Projected EBT is $12 Mill CAD @ EUR=$1.3536 CAD
Loan covenant EBT > $9 Mill CADUnderstand tools to manage currency
exposureRecent trend shows CAD appreciatingIf CAD depreciates, projected EBT not met
Define the Issue - Transaction Risk
A large portion of its expenses are paid in EUR
• All of the company’s revenues are denominated in CAD
• A monthly licensing fee of 250,000 EUR• Raw materials necessary for the
manufacturing of Cryolac• Costs of servicing: 1 million EUR note for
partial payment of the upfront licensing fee
Analyze the Case
Projected EBT@ CAD $1.3536/EUR• Projected Expense in CAD $ 49,944,000(will
pay in EUR)• Converted to EUR 36,897,163 at the budgeted
exchange rate of 1.3536 CAD/EUR• Budgeted EBT (CAD/EUR)• CAD $62,002,000-CAD $49,944,000 = CAD
$12,058
Case Data Analysis - Basic Issues
IMPORTANCE
URGENCY LOW HIGH
LOW
HIGH
Case Data Analysis - Basic Issues
IMPORTANCE
URGENCY LOW HIGH
LOW Economic Risks
HIGH
Case Data Analysis - Basic Issues
IMPORTANCE
URGENCY LOW HIGH
LOW Economic Risks R&D in Domestic
HIGH
Case Data Analysis - Basic Issues
IMPORTANCE
URGENCY LOW HIGH
LOW Economic Risks R&D in Domestic
HIGHShipment Risks
Case Data Analysis - Basic Issues
IMPORTANCE
URGENCY LOW HIGH
LOW Economic Risks R&D in Domestic
HIGHShipment Risks Increasing
market shares
Case Data Analysis - Immediate Issues
IMPORTANCE
URGENCY LOW HIGH
LOW
HIGH
Case Data Analysis - Immediate Issues
IMPORTANCE
URGENCY LOW HIGH
LOWPolitical risks
HIGH
Case Data Analysis - Immediate Issues
IMPORTANCE
URGENCY LOW HIGH
LOWPolitical risks Competitors
HIGH
Case Data Analysis - Immediate Issues
IMPORTANCE
URGENCY LOW HIGH
LOWPolitical risks Competitors
HIGHUnderstanding the effect of currency exposure
Case Data Analysis - Immediate Issues
IMPORTANCE
URGENCY LOW HIGH
LOWPolitical risks Competitors
HIGHUnderstanding the effect of currency exposure
Currency Exchange Risks
Cause/Effect diagram
Comparing the decision criteria
Sources of financial restriction facing
Westwood
The best alternative hedging strategy for
the company
Measurement of hedges and exposures
Currency trends
CAD per 1 EUR Exchange Rate Chart(Jan 1999 – Jan 2006)
Trend Line
•If CAD continue to appreciate against EUR at present rate, then year end EBT will be C$13,069 thousand.
CAD per 1 EUR Exchange Rate Chart (Jan 2005 – Jan 2007)
EBT forecast without hedge (Assume exchange rate move on 3/1/06 and stay at level)
€/C$ exchange rate 1.3336 1.3536 1.3736 1.3936 1.4136 1.4365
Revenue (C$) 160,000 160,000 160,000 160,000 160,000 160,000
COGS (€ component) 45,084 45,760 46,436 47,112 47,788 48,562
COGS (C$ component) 67,935 67,935 67,935 67,935 67,935 67,935
Gross Margin 46,981 46,305 45,629 44,953 44,277 43,503
License Fee (€) 4,001 4,061 4,121 4,181 4,241 4,310
Depreciation (C$) 9,640 9,640 9,640 9,640 9,640 9,640
Selling and Admin. (C$) 19,232 19,232 19,232 19,232 19,232 19,232
Interest (€ component) 121 123 125 127 128 131
Interest (C$ component) 1,191 1,191 1,191 1,191 1,191 1,191
Total expense 34,185 34,247 34,309 34,371 34,432 34,503
EBT 12,796 12,058 11,320 10,582 9,844 9,000
1/3/2005
1/27/2
005
2/20/2
005
3/16/2
005
4/9/2005
5/3/2005
5/27/2005
6/20/2005
7/14/2
005
8/7/2005
8/31/2
005
9/24/2
005
10/18/2005
11/11/2005
12/5/2005
12/29/2005
1/22/2
006
2/15/2
006
3/11/2
006
4/4/2006
4/28/2006
5/22/2
006
6/15/2
006
7/9/2006
8/2/2006
8/26/2
006
9/19/2
006
10/13/2006
11/6/2006
11/30/2006
12/24/2006
1/17/2007
2/10/2
0071
1.1
1.2
1.3
1.4
1.5
1.6
1.7
1.8
EURCAD Projectionfrom current trend
Hisotical C$ appriciate MinEBT C$ Depreciate
1.4365
Generate AlternativesHedging Vehicles
Call Option
Premium
Put Option
Premium
Forward Contract
Margin – 8% of face value
Decision CriteriaAlternatives
Decision Criteria
Risk Cost Profit Flexibility
Put OptionHigh( - )
Medium(0)
High(+)
High(+)
Call OptionLow( + )
Medium(0)
High(+)
High(+)
Forward Contract
Low(+)
Low(+)
Low(-)
None(-)
Use of Put option is speculative!
Analyze & Evaluate AlternativesCall Options Put Options Forward
Contract Cost = 50,960,000
(1,016,000 + 49,944,000) CAD
Premium % of EBT = 8.4%
= 49,944,953 (953,000 + 49,944,000) CAD
Premium % of EBT = 7.9%
= 50,343,412 CAD
Analyze & Evaluate Alternatives
Alternative Hedge method
Up-font Hedge Cost (Premium)
Margin Req.
Average balance
Loss of interest income
Hedged EBT
Potential Loss if rate is
Potential Loss
Amount
Potential Gain if rate is
1 No Hedge
- -
-
-
> 1.3536
Unlimited < 1.3536
2 Buy Call Option 1,016
-
-
11,042 None
1,016 < 1.3260
3Enter into Forward
Cont.
-
2,186 109
11,659 None None None
4 Buy Put Option
953 -
-
-
> 1.3536 953 < 1.3278
Conclusions
• Westwood Plastics will use the call option as the optimal hedging strategy– Call Options Advantages
• Doesn’t tie up a lot of capital• Limits potential losses without limiting
potential gains
Historical Exchange Rate Trend(Jan 2004 – Jan 2009)
Questions???