Blades Inc

Topics: Futures contract, Option, Derivative Pages: 7 (2424 words) Published: June 10, 2012
Blades, Incorporated has been exporting to Thailand since its decision to supplement its declining U.S. sales. This decision seems ideal due to the Southeast Asia fast growing economies. With this in mind, this paper will analyze the Blades, Inc. case in Chapter 5 of the textbook by discussing the feasibility for Ben Holt, the chief financial officer, to move forward to hedging Blades’ yen payables position, the advantages and disadvantages associated with purchasing derivatives instruments such as call options and future contracts, the use of the market consensus of the future yen spot rate provided to determine the optimal hedge for the firm and the danger and/or value of using derivatives as a risk management tool (Madura, 2009).

B) Section A-Should Ben Holt be advised to move forward to hedge Blades’ yen payables position? Why?
It would be a wise decision for Ben Holt to move forward with hedging Blades’ yen payables position, for the simple fact that the volatility of the yen has historically been erratic. The text defines hedging as “a practice where exporting companies contract with a bank that guarantees the exporter a fixed number of U.S. dollars in exchange for payment of the goods it receives in a foreign currency” (Kubasek, Brennan, & Browne, 2009, p. 267). The exporting company pays a fee to the bank; the fee is based on the risk the bank is taking that the foreign currency will fluctuate (Kubasek, Brennan, & Browne, 2009, p. 267). By hedging, Holt will be taking preventative measures to safeguard Blades against trading with uncertainty.

There are several options Holt can choose from to hedge Blades’ yen payables. He can choose to purchase a futures contract, purchase two call options contracts, or purchase currency put options. The text states, “If a firm that buys a currency futures contract decides before the settlement date that it no longer wants to maintain its position, it can close out the position by selling an identical futures contract” (Madura, 2010, p. 125). Holt likes the flexibility of using futures contracts; should the yen depreciate, he can let the contracts expire. The case goes on to suggest that Holt would like to use an exercise price that is about 5 percent above the existing spot rate to ensure that Blades will have to pay no more than 5 percent about the existing spot rate for a transaction 2 months beyond its order date, as long as the option premium is no more than 1.6 percent of the price it would have to pay per unit when exercising the option. (Madura, 2010, p. 147).

The practice of hedging will allow Blades to continue exporting to Japan despite the uncertain future of the Japanese yen. In the future, the company has considered the idea of remaining un-hedged if the yen were to stabilize. C) Section B-Advantages and Disadvantages of Call Options

The purposes of call options are to elect a maximum rate to which an investor would be willing to purchase a currency, such as the Japanese yen for Blades, Inc. where Ben Holt wishes to hedge its payables. The purchase of the two call options would be an appropriate action to take for a company that is in the process of ordering supplies from another country. The thought is that the currency in the purchasing country, Japan, will potentially increase in value and thus capitalizing on a fixed price that is less than the increased value. Once the call options are exercised at the lower price, Blades, Inc. could sell the option for the higher price and make a profit; minus the premium paid for volatility, expiration period, and ratio of spot price versus exercise price (Madura, 2008).

Some of the advantages of call options involve flexibility, less risk, potentially higher returns, and more efficient use of money. With call options Blades, Inc. would have the ability to either exercise the call or allow it to expire if the value of the currency did not increase as previously thought or if the...
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