This case required us to evaluate various methods of financial hedging and pick the best one for Saudi Fertilizers Company.

1. Semester:
Fall 2013/2014
Course Code:
FINA4314
Course Title:
International Finance_102
Instructor:
Dr. Dawood Ashraf
Section:
102
Students Name
Ahmed AlJabr 201001926
Mohammed AlHashim 201103005
ZiadAlSalim 200600697
&ID Number
Study case #1: Saudi Fertilizers Company
Date: 8th of December 2013
Submission Date: 8th of December 2013

2. First case study
Introduction
Saudi Fertilizers Company (SFC) is a company that wants to buy a shipping
vessel in order to move their shipments across the world. Due to recent Somalian
pirates’attacks on western flag carriers, SFC had to buy a ship of their own. They have
contacted Mitsubishi Industries in Japan (a well-known global enterprise) in order
manufacture a shipping vessel for them. Mitsubishiprovided SFC with discretion in terms
of the payment method. They can either pay ¥15,000,000,000 over a period of 22 months
or make a single payment amount of ¥13,930,000,000.
The first payment will be paid on the date of signing the contract
(¥3,750,000,000). The second payment will be on July 30, 2012 (¥3,750,000,000). The
third payment will be on January 31, 2013 (¥3,750,000,000). The fourth and last payment
will be on September 30, 2013 (¥3,750,000,000).
Date
November-15-2011
July-30-2012
January-31-2013
September-30-2013
Total CFs=
¥
Japanese Yen
15,000,000,000
Cash Flow in JP ¥
¥
3,750,000,000
¥
3,750,000,000
¥
3,750,000,000
¥
3,750,000,000
$
US Dollars
194,704,050
SAR
Saudi Riyals
730,140,187
Based on that, SFC has to decide on the payment method to choose from and they
have been given two weeks to do so. Apparently, they would have to choose the method
which will save them most costs.
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3. First case study
Assumptions
In order to proceed with this case, the following assumptions had to be made. All of
which are in fact real data that has been obtained from various websites.
A. November 15, 2011 spot rate was not provided in the case. Therefore, it was
recovered from (http://www.exchange-rates.org) $1= ¥77.04 / ¥1= $0.01298.
B. Since SFC is a corporation that is dominated in Saudi Arabia, their payments had
to be made in Saudi Riyals (SAR). It is known that the value of SAR is pegged
with the US$ as the following: $1= SAR3.75
Based on the data recovered from this website and other assumptions, the following
table was created to describe with multiple cross exchange rates. All of the following
exchange rates describe cross exchange rates as ofNovember 15, 2011.
15-Nov-11
Currency
Exchange Rate
$1=
¥
77.04
$1=
SAR
3.75
¥1=
$
0.01298
¥1=
SAR
0.05
SAR 1=
$
0.27
SAR 1=
¥
20.54
*Source for JPY/USD Exchange Rate: http://www.exchange-rates.org
*Value of SAR/USD and USD/SAR is constant.
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4. First case study
Assessment of Different Payment Methods
Down below we have looked into all possible payment methods. Each method has
provided a different cost according to its nature.
1- Single Payment Method (Using November 11th, 2011 Exchange Rate as a
Fixed Exchange Rate)
Mitsubishi Industries has offered SFC to pay ¥13,930,000,000 as a single payment. In
order to determine how they have arrived at this amount, we had to estimate the present
value (PV) of future cash flow payments. The required rate of return (K) of 8% -decided
by Mitsubishi industries- was used as the discount rate.
Annual Required Rate of Return=
Monthly Required Rate of Return=
Total Months
Period (in Months)
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
Month
Nov-11
Dec-11
Jan-12
Feb-12
Mar-12
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
8%
0.6667%
22 Months
Discounted CFs in JPY
¥
3,750,000,000
¥
3,725,165,563
¥
3,700,495,592
¥
3,675,988,999
¥
3,651,644,701
¥
3,627,461,623
¥
3,603,438,699
¥
3,579,574,866
¥
3,555,869,073
¥
3,532,320,271
¥
3,508,927,421
¥
3,485,689,491
¥
3,462,605,455
¥
3,439,674,293
¥
3,416,894,993
¥
3,394,266,549
¥
3,371,787,963
¥
3,349,458,241
¥
3,327,276,399
¥
3,305,241,456
¥
3,283,352,439
¥
3,261,608,384
¥
3,240,008,328
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5. First case study
PV of Relative CFs in JPY=
PV of Relative CFs in USD=
PV of Relative CFs in SAR=
¥
$
SAR
13,962,772,394
181,236,786
679,637,946
*Relative cash flows are indicated by a red color.
2- 4x4 Payments Using Forward Contracts.
Now, we assess the payments using the forward contracts with their provided forward
rates. There are a total of 3 forward contracts. The table below will show the effect of
forward rates upon the future payments.
Payments
Date
November-15-2011
July-30-2012
January-31-2013
September-30-2013
Forward Rate
N/A
¥ 81.70
¥ 81.20
¥ 80.20
Japanese Yen
¥ 3,750,000,000
¥ 3,750,000,000
¥ 3,750,000,000
¥ 3,750,000,000
US Dollars
$ 48,676,012
$ 45,899,633
$ 46,182,266
$ 46,758,105
Saudi Riyals
SAR 182,535,047
SAR 172,123,623
SAR 173,183,498
SAR 175,342,893
*The first payment was calculated using November 11th, 2011 exchange rate.
Total w/o Discount=
¥
15,000,000,000
$
187,516,016
SAR 703,185,060
Now we must discount the cash flows to arrive at today’s present value (PV).
Period (in months)
0
8
14
22
Discounted Total=
Month
Nov-11
Jul-12
Jan-13
Sep-13
$
$
$
$
CFs in USD
48,676,012
45,899,633
46,182,266
46,758,105
¥ 13,962,772,394
Discounted CFs in USD
$
48,676,012
$
43,523,489
$
42,079,988
$
40,399,106
$ 174,678,596
Annual Required Rate of Return=
Monthly Required Rate of Return=
Total Months
SAR 655,044,734
8%
0.6667%
22 Months
*The table above explains the used discount rate.
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6. First case study
3- 4x4 Payments Using Call Options.
Here, we are measuring the payments using the call options to buy Japanese Yens
(JPY) with their provided exercise rate. There are a total of 3 call options. The table
below will show the effect of call options upon the future payments.
¥ 81.90
Exercise Price
Option Date
Nov-11
Jul-12
Jan-13
Sep-13
Premium in USD
N/A
$524,000
$587,000
$640,000
¥
¥
¥
¥
Per $
CFs in JPY
3,750,000,000
3,750,000,000
3,750,000,000
3,750,000,000
$
$
$
$
CFs in USD
48,676,012
45,787,546
45,787,546
45,787,546
*The first payment was calculated using November 11th, 2011 exchange rate.
Total w/o Discount
Total Premiums
Overall Total
$
$
$
186,038,650
1,751,000
187,789,650
Now we must discount the cash flow to arrive at today’s present value (PV)
Period (in months)
0
8
14
22
Month
Nov-11
Jul-12
Jan-13
Sep-13
$
$
$
$
Discounted Total=
Total Premiums=
Overall Total=
CFs in USD
48,676,012
45,787,546
45,787,546
45,787,546
$
$
$
Discounted CFs in USD
$
48,676,012
$
43,417,205
$
41,720,330
$
39,560,541
173,374,088
1,751,000
175,125,088
4- 4x4 Payments without Hedging.
By reviewing the historical data and the trend in the value of USD against JPY, it is
very clear that the JPY is rapidly appreciating against the USD. In other words, this
means that the USD is depreciating against the JPY. Although there are rumors that the
Japanese government might consider some initiatives which might decrease the value of
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7. First case study
JPY, yet we have to go with the mainstream trend and the experts’ analysis in taking our
financial decisions. We cannot fully place our hopes on dim expectations.
Basically, since SFC is a Saudi company which will use USD to buy JPY – which
most likely is going to appreciate against USD – to pay for Mitsubishi Industries, an act
of not hedging future payables would call for a disastrous loss. This means that by not
hedging payables, SFC would almost certainly would have to pay more money in USD to
meet the required payments in JPY; it’s a very risky tactic.
Comparison of Payment Methods
The following table sums up all possible payment methods and the cost for each
method in USD. The costs had to be measured in today’s present value (PV) because SFC
is making the decision today.
Payment Method
Single Payment (Mitsubishi Offer)
4x4 Payment (Assuming Fixed Exchange Rate)
4x4 Using Forward Contracts
4x4 Using Call Options
Total Cost w/o Discount
$ 180,811,400
$ 194,704,050
$ 187,516,016
$ 186,038,650
Total Cost with Discount
N/A
$
181,236,786
$
174,678,596
$
175,125,088
First of all, when comparing a single payment method (as offered by Mitsubishi)
with 4x4 payment method(assuming a fixed exchange rate), it seems that the single
payment is better by minimal difference.
After discounting the future payments of ¥3,750,000,000 at the rate of 8%
compounded monthly, the total discounted cash flows clearly describes how Mitsubishi
has come up with this estimation.
Single Payment=
Standard 4x4 Payment=
¥
¥
Difference=
Difference ( in Percentage)=
¥
Japanese Yen
13,930,000,000
13,962,772,394
32,772,394
0.235%
$
$
$
US Dollars
180,811,400
181,236,786
425,386
Saudi Riyals
SAR
678,042,750
SAR
679,637,946
SAR 1,595,196
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8. First case study
We notice here that the difference between the two different payment methods is
relatively minor. This could be considered as discount by Mitsubishi for SFC. That is, to
urge them to pay now, rather than later on.
Secondly, when comparing between forward contracts and call options without
discounting future cash flows, it might seem that call options will provide a lower cost
and thus are better. However, after accounting for the time value of money and estimating
the PV for the future payments for both derivatives, forward contracts turned out to be
better by a minimal difference. Even though call options are better before discounting the
cash flows, yet they are worse because they have a premium which must be paid at Nov
11th, 2011 (the day of buying the options). Consequently, the premiums for these options
will be added to the total value without discounting them, resulting in a higher cost.
Since the mainstream analysis suggests that USD value will most likely
depreciate against JP and vice versa, we can safely assert that the no-hedge payment
method is absolutely out of the question. If SFC has decided to go for this method for any
reason, they would definitely end up paying more USD to buy JPY.
Conclusion: Decision
In a nutshell, SFC had a choice between many techniques to pay for the shipping
vessel. The costs of each technique varied according to its nature. After reviewing all
possible payment methods and making numerous comparisons across them, we would
advise SFC to choose call options as the best suitable payment method. Although they
would cost a little more than forward contracts, yet they would provide SFC with the
flexibility to make future decisions. The little difference in the cost of call options is
definitely worth paying for, for they provide a right and not an obligation. Nevertheless,
forwards contracts are still good, yet they remain an obligation which must be fulfilled by
both parties in the contract. In this case, call options are worth paying more to get them as
they can be used or dropped depending on the future market spot rates.
Page 7