RUNNING HEAD: Aussie Crazy Skateboard currency and operating exposure analysis
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ASSESSMENT TITLE
Assessment 2
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31/05/2019
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Huiping Zhang
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Huiping Zhang
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Aussie Crazy Skateboard currency and operating exposure analysis
Aussie crazy skateboard currency and operating exposure analysis
Group assessment
Lecture name
:
Huiping Zhang
Subject code
:
BX3031
Submiss date
:
31/05/2019
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:
four (4)
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:
2371
Group member
:
Sangyeon Moon
13525936
Yehezkiel Kurnia Ardaniv
13569133
Xinyi Kuang
13530677
Pham Thai An
13412105
Martha Zahkung Nu San
13449129
Aussie Crazy Skateboard currency and operating exposure analysis
Contents
Introduction
4
Currency exposure
5
ACS cashflows
5
Hedging Strategy
7
1, Hedging strategy for Thai Bath
7
2) Hedging strategy for GBP
8
3) comparison of alternative
10
4) over hedging
12
Operating exposure
13
Operating exposure management
13
Matching currency cash flows
13
Risk-sharing
13
Currency swaps
14
Reinvoicing centers
14
Operating exposure is caused by new competitors entering in the market
14
Reference
15
Appendix
16
Aussie Crazy Skateboard currency and operating exposure analysis
Introduction
Aussie Crazy Skateboard, Pty LTD is an Australia based company. It is SME, producing
skateboard with the total assets of AUD 200 Million. Due to the Australia local demand is slowing
down and the company is not performing well, Angus Smith, CFO of Aussie Crazy Skateboard
trying an alternative to export the Cruiser to Thailand. He also liked to import some of the
components from Thailand. Beside Thailand, there are some countries for the export and import
the products such as Japan, and United Kingdom.
This assignment will discuss on how Aussie Crazy Skateboard managing their currency exposure
and operating exposure using company exporting and importing situation and market information.
Aussie Crazy Skateboard currency and operating exposure analysis
Currency exposure
Trading in other currencies impact the companies’ profit. Aussie Crazy Skateboard (ACS),
Pty Ltd is an Australia-based company have currency exposure due to the transaction risk faced
by company involved in international trade. Currency exposure is a term referring to the
vulnerability of an investment, cash flow or financial position to variations in the exchange rate of
two currencies (Kantox, 2019). Exposure of foreign currency movement systematically increase
the variation of foreign returns in the domestic currency. ACS is experiencing transaction exposure
which is the exchange rate risk of foreign currencies that is potential outcome of misfortune loss
form a result of adverse evolution of the foreign exchange rate. There is the foreign exchange rate
that will cause increase or decrease of the currencies when ACS is converted bACS to all the
foreign currencies to the local currency. Moreover, ACS is also experiencing economic exposure
as they are exporting their products to Thailand with fixed contract of three years and UK and
importing components for their products from Thailand and Japan annually in foreign currencies.
Economic exposure result in future and unknown transactions in foreign currencies resulting ACS
in a long-term involvement in a particular market.
ACS cashflows
Aussie Crazy Skateboard currency and operating exposure analysis
If Aussie Crazy Skateboard does not enter the British company but continues its current importing
and exporting transactions in japan and Thailand, the increased correlation between Japanese yen
and Thai baht will decrease the Aussie Crazy Skateboard’s transaction exposure. Because Aussie
Crazy Skateboard earns net inflows denominated in Thai baht, but net outflows denominated in
Japanese yen. For example, if the Thai baht depreciates, resulting in reduced Australian dollar
revenue, the Japanese yen will also depreciate, resulting in reduced Australian dollar costs.
Importing component from Japan is not proper way to reduce its net transaction exposure in the
long run. Although the correlation between the Thai baht and the Japanese yen is currently quite
high, it has been low and unstable in the past. Once the current economic problems that caused the
currently high correlation, the correlation between the two currencies will probably return to its
normal level. If Aussie Crazy Skateboard is going to reducing its net transaction exposure by
importing from Japan because of the high correlation between the two currencies, Aussie Crazy
Aussie Crazy Skateboard currency and operating exposure analysis
Skateboard’s net transaction exposure may actually increase once the correlation between the baht
and the yen return to normal levels.
Hedging Strategy
1, Hedging strategy for Thai Bath
Remain unhedged
The company can select not to hedge. However, it would have to suffer from the foreign exchange
risk. The presence of claims or debts denominated in foreign currencies on the balance sheet of an
enterprise will directly impact on the value of debts and receivables. For Angus, it will suffer from
the risk of appreciation of baht and the depreciation of AUD. It may pay more AUD in 90 days for
importing the ra materials of Cruiser.
In the unhedged case, Angus will directly pay money for the imported components from Thailand.
The cost per unit of Cruiser is 3,000 baht and Angus should import 72,000 units of skateboard.
The total spending will be 216 million baht (3,000 baht * 72,000 units). At that time Angus should
pay exchange AUD in spot market for this amount of baht.
The spot rate in 90 days is:
5% * A$ 0.0200 + 20% * A$ 0.0213 + 30% * A$ 0.0217 + 25% * A$ 0.0220 + 15% * A$ 0.0230
+ 5% * A$ 0.0235 = A$ 0.021895
The payment for skateboard will be 216 million baht * A$ 0.021895 = 4,729,320 AUD.
Hedge in the forward market
In this case, Angus can purchase 90-day forward contract of 216 million baht in current with a rate
of A$ 0.0215. He will spend: 216 million baht * A$ 0.0215 = 4,644,000 AUD.
Aussie Crazy Skateboard currency and operating exposure analysis
In 90 days, since the spot rate is A$ 0.021895 > forward rate A$ 0.0215, Angus can execute the
forward contract. Hence, he could obtain 216 million baht with a spending of 4,644,000 AUD.
Then, he will pay the obtained 216 million baht to the Thailand supplier.
Comparing this case to the unhedged case, Angus spends less AUD with the help of forward
contract.
He
can
save:
4,729,320
AUD
-
4,644,000
AUD
=
85,320
AUD.
Hedge in the money market
For the hedge in money market, Angus should borrow 216 million baht from the bank. The loan
period will be 90 days. The interest will be 216 million baht * 4% = 8,640,000 baht.
The spot rate is A$ 0.0230. Angus should sell baht in spot market and obtain AUD. He will obtain:
216 million baht * A$ 0.0230 = 4,968,000 AUD.
Then, Angus deposits 4,968,000 AUD in the market for 90 days with an interest rate of 2.1%. The
interest will be 104,328 AUD.
In 90 days, Angus will obtain 4968000 AUD + 104,328 AUD = 5,072,328 AUD from the bank.
Then, he should transfer it to baht: 5,072,328 AUD / 0.021895 = 231,666,042.5 baht. Then, he
should pay the loan of baht and interest: 216 million baht + 8,640,000 baht = 224,640,000 baht.
The left amount will be: 231,666,042.5 baht - 224,640,000 baht = 7,026,042.475 baht, which
equals to 153,835.2 AUD (7,026,042.475 baht * A$ 0.021895).
Hedge in the option market
According to the case, it is not available for Thailand to use option hedge strategy.
2) Hedging strategy for GBP
remain unhedged
Aussie Crazy Skateboard currency and operating exposure analysis
Forward hedged
Money market hedged
– Borrow GBP in Australia bank at 2.3% per quarter
£
4 250 000
1+0.023
= £ 4,154,447.703
– Repay the loan £ 4,154,447.703 with interest £95,552.29 from the sale proceed
– Exchange £4,154,447.703 loan proceed for Australian dollar
GBP4,154,447.703× AUD1.50 = AUD 6,231,671.555
Hedging with option
-
Buy the put option to sell GBP
-
Each Put option cost: £31,250 × AUD 1.50/£= AUD 46,875
Aussie Crazy Skateboard currency and operating exposure analysis
𝐴𝑈𝐷 46,875
-
right to sell:
-
number of option need to buy: 𝐺𝐵𝑃 2,343,650 = 1.81
𝐴𝑈𝐷 0.02/£
= GBP 2,343,750
𝐺𝐵𝑃 4,250,000
the firm need to buy 2 options to hedge
-
put option premium = AUD 46,875 × 2= AUD 93,750
– If ST > AUD1.47/£, the firm won’t exercise the put. It will sell GBP 4,250,000 at
ST in the spot market.
– If ST <= AUD1.47/£, the firm will exercise the put. It will sell GBP 4,250,000 at
the exercise price of AUD1.47/£ in the option market.
•
If ST = AUD1.484/£
– The proceeds three months later are
GBP 4,250,000 * AUD1.484/£ - AUD93,750 * (1+ 2.3%) = AUD 6,211,093.75
•
If ST = AUD1.45/£
– The proceeds three months later are
GBP 4,250,000 * AUD1.47/£ - AUD93,750 * (1+ 0.023) = AUD 6,151,593.75
– This is the lowest proceeds the firm can get.
3) comparison of alternative
A, hedging strategy for TBH
Compared with unhedged strategy, the hedge in the forward market can bring a profit of 85,320
AUD and the hedge in the money market will bring a profit of 153,835.2 AUD. The profit in
Aussie Crazy Skateboard currency and operating exposure analysis
money market is higher than that in forward market. Hence, Angus should adopt the strategy of
hedge in money market which is the most appropriate.
B, hedging strategy for GBP
If Angus decides to remain unhedged, Aussie crazy Skateboard will expect to receive AUD
6,307,000. However, the finance department predicts that the exchange rate will drop to AUD
1.484/£. Hence, using forward hedged will help the firm receive more Australia dollar after 90
days, i.e. AUD 6,332,500. However, if the forward rate equals to future spot rate, the result from
unhedged strategy are similar to certain result from forward hedging strategy. In this case, the
advantage of hedging is the minimize of uncertainty.
Moreover, the money market hedge is greater than forward rate if Angus used the loan to invest
in bank deposit or replacing the loan in Australia bank. In this circumstance, using loan to
replace the debt cost in bank will be preferable choice because the money received after 90 days
will be greater approximately AUD 13,000.
Even if the exchange rate moves in the Australia Crazy Skateboard’s favor, the receivable
Australia dollar will be much smaller than remain unhedged due to the high put option premium
price. If the exchange rate moves against firm’s favor, the put option will reduce the downside
risk. However, the put option exercise price is low, i.e. AUD 1.47/£. Hence, the money received
by using put option to hedge will be smallest as compare to another hedging strategy.
In overall, Angus should hedge using money market hedge strategy, specifically using loan to
replace the loan in Australia bank, for the British pound receivables.
C, Hedging cashflow
Aussie Crazy Skateboard currency and operating exposure analysis
According to the sample of British Pounds and Thailand Bath, it can be concluded that Aussie
Crazy Skateboard easier to hedge its inflows denominated in foreign currencies because based on
the sample of Pound sterling and Bath, firm is earning profit by converting the foreign currencies
to the local currency (Australian Dollar) and investing in money market or forward market in
Australia. After the period of investing, they convert the Australia Dollar back to the foreign
currencies and pay the agreement to the client(s) in the foreign currencies. The profit from
investment in Australia’s market is saved as an investment profit. This situation subject to the
current currencies rate and also the rate offered in the hedges.
4) over hedging
For British pounds to be received in the next 90 days, ACS needs to take over the hedge by using
option hedge. In order to hedge entire GBP, ACS buys 2 options while they only need 1.8 options.
Hence, this over hedging is predicted.
Comparing the exporting arrangement plan to Thailand and UK market, with the profit that might
be getting at the end of the period, it is profitable when firm put the money with over hedging in
the money market hedge. In the Thailand case, when ACS has put the money in the forward market,
it makes a profit for AUD 85,320.00. In the money market, the profit is AUD 153,835.20. In the
UK market, the firm gets profit by put the money into the money market hedge, like investing in
bank deposit and pay debt cost, i.e AUD139,163.00 and AUD151,840.00, respectively.
It can conclude that the over-hedging, especially in the money market hedge, will be profitable.
He also needs to observe and care about market information.
Aussie Crazy Skateboard currency and operating exposure analysis
Operating exposure
Operating exposure management
By entering exporting agreements, Aussie Crazy Skateboard (ACS) could fully expose to the
foreign exchange risk. Hence, there are several ways to minimize the risk by using some longterm hedging technique such as: matching currency cash flows, risk-sharing agreements,
currency swaps and re-invoicing center. It is important to take note that long-term hedging is
expensive, and the firm may not be able to afford it.
Matching currency cash flows
If Angus keeps importing components into Japan, the firm should acquire the debt from the
Japan bank in Yen to offset an anticipated continuous exposure to the changing in exchange rate
between Japanese Yen and Australia dollar. Angus may want to attempt to engage in currency
switching with Japan firm in which ACS will pay Japan firm in Australia dollar.
In Thailand case, Aussie Crazy Skateboard may want to look for the potential supplier for the
raw component in Japan as the substitute for Thailand firm. Moreover, ACS can take a loan from
Thai Bank to hedge the surplus between exporting and importing income in Thai baht.
Risk-sharing
Moreover, risk-sharing is another way to hedge. ACS and Thai firm can agree that all the
purchased and export by ACS will be made in Thai baht at the spot exchange rate as long as the
rate is between the agreement rate. If the exchange rate falls between this rate, ACS will accept
all the transaction exposure. However, if the rate falls outside of the range, both firms will share
the difference evenly.
ACS can apply the same strategy in the relationship with Japan firm.
Aussie Crazy Skateboard currency and operating exposure analysis
Currency swaps
ACS may approach bank or swap dealer to ask for the off-balance sheet swap. However, two
firm only agree get into the swap if both of firms wish to enter the swap and getting benefit.
Hence, the currency swap may not be available all the time.
Reinvoicing centers
A reinvoicing center is separate subsidiary that serves as a type of “middleman” between the
parent or related unit in one location and the rest subsidiaries in a geographical region. ACS can
setup its own reinvoicing centers in Thailand or Japan or the third country to hedge the risk.
However, this strategy is extremely expensive to setup and maintenance. Hence, it might not be
suitable for SME like ACS.
Operating exposure is caused by new competitors entering in the market
Moles and Bradley (2002) mentioned that operating exposure is about how unexpected future
exchange rate changes, especially when competitors providing similar products in the same
market. One of the determinants of economic exposure is the competitive structure of the
industry where a firm operates. In competitor group, a firm which has the lowest price will have
higher revenue, so this firm will have greater economic exposure.
ACS would have an advantage with competition when the Thai baht appreciated, because its
competitor products’ price will be lower than ACS. Also, increase ACS’s market share or would
have a higher profit margin. However, it would have disadvantage relative to the competition
when the Thai baht depreciated and may lose market share or get a lower profit margin. The
china and japan firms’ amount gained for exports would depend on exchange rate movements.
Thus, ACS retain their existing market share, and have greater economic exposure.
Aussie Crazy Skateboard currency and operating exposure analysis
Reference
Kantox, (2019). Currency exposure. Retrieved from
https://www.kantox.com/en/glossary/currency-exposure/
Moles, P., & Bradley, K. (2002). The nature and determinants of the economic currency
exposure of non-financial UK firms. Managerial Finance, 28(11), 1-15.
Aussie Crazy Skateboard currency and operating exposure analysis
Appendix
Appendix 1. exporting and importing of ACS
appendix 2. expected spot exchange rate
appendix 3. comparing hedging strategy for GBP
Aussie Crazy Skateboard currency and operating exposure analysis
Thailand
cash inflow
Net inflows for a year = 180,000 unit * THB 4594/unit = THB 826,920,000
Possible Net inflow in AUD at exchange rate of A$0.030/THB
=THB826,920,000*A$0.030/THB=A$24,807,600
Possible Net inflow in AUD at exchange rate of A$0.038/THB
=THB826,920,000*A$0.038/THB=A$ 31,422,960
cash outflow
Net outflows for a year =72,000 unit*THB 3695=THB 266,040,000
Possible Net outflow in AUD at exchange rate of A$0.030/THB
=THB266,040,000*A$0.030/THB=A$ 7,981,200
Possible Net outflow in AUD at exchange rate of A$0.038/THB
=THB266,040,000*A$0.038/THB=A$ 10,109,520
Net Cash flow in AUD= (THB826,920,000*A$ 0.034/THB) - (THB266,040,000*A$0.034/
THB) =A$19,069,920
Japan
Import = cash outflow
Net outflows for a year = 1,700 unit * ¥ 8,600 = ¥ 14,620,000
Possible Net outflow in AUD at exchange rate of A$0.01126/¥
Aussie Crazy Skateboard currency and operating exposure analysis
= ¥ 14,620,000 * A$0.01126/¥ = A$ 164621.2
Possible Net outflow in AUD at exchange rate of A$ 0.038/¥
= ¥ 14,620,000 * A$ 0.038/¥ = A$ 555560
Net cash flow in AUD = 0 – (¥ 14,620,000 * A$ 0.0130/¥) = - A$190,060
British
cash inflow
Net inflows for a year =200,000 unit * £85= £17,000,000
Possible Net inflow in AUD at exchange rate of A$1.67/£
=£17,000,000* A$1.67/£=A$28,390,000
Possible Net inflow in AUD at exchange rate of A$1.73/£
=£17,000,000*A$1.73/£= A$29,410,000
Net cash flow in AUD = £17,000,000 * A$1.70/£= A$28,900,000