baker adhesives

Baker Adhesives (Baker) has just made its first foray into international sales and must come to grips with the impact of exchange-rate changes on the profitability of a past order. The company must also formulate a strategy for dealing with exchange-rate risks for future orders. The case is intended as an introduction to exchange-rate risk and the management of that risk. Upon receipt of payment from a past order, the firm realizes that exchange-rate movements have reduced the value of the sale. A follow-on order provides the context for exploring possible mechanisms for managing that risk. In particular, sufficient direction and information is provided to examine both a forward hedge and a money-market hedge.

The learning objectives of the case are as follows:

• To explore the magnitude and effect of exchange-rate risks.
• To illustrate exchange-rate risk management through two conventional hedges—a forward-contract hedge and a money-market hedge.
• To demonstrate market parity and identify how preferences arise from unique company characteristics.
• To explore issues related to pricing of international bids.
Hedging

Before exploring the two hedges, it is useful to ask what the present value of the expected cash flow would be if Baker remains unhedged. One may question the need to calculate a present value. The cash flow obtained from a money-market hedge and that cash flow will be a current cash flow. Thus, one will either have to calculate present values or future values to make comparisons—and the present value is more naturally interpreted.

The case provides information on market expectations that allows this calculation. This amount is a useful benchmark to the extent that there may be trade-off between risks and expected cash flows.

For a money-market hedge, the steps look like:

Foreign Currency Outflow
(payable) Foreign Currency Inflow
(receivable)

• Convert on spot market to foreign currency
• Invest in money market
• Pay