Synopsis and Objectives
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.
1. How profitable is the original sale to Novo once the exchange-rate changes are acknowledged? How might the exchange-rate risk, which affected the value of the order, have been managed? 2. Assuming Baker agrees to the new Novo sale, determine the present value of the expected future cash inflow assuming: (1) there is no hedge, (2) the company hedges using a forward contract, and (3) the company hedges using the money market. Finding a present value is necessary for the following reason: With no hedge or a with forward-contract hedge, the cash flow will occur at the time of payment by Novo. With the money-market hedge, Baker receives a cash flow immediately. 3. Are the money markets and forward markets in parity?
4. How profitable will the...