1. i
COVER PAGE
Title : Case Analysis – Hedging Foreign
Currency Transaction Exposure
Subject : International Financial Management
Level / Semester : III / Oct 2010
Programme : MBA - FULL TIME
Subject Tutor : Mr. S.P. Srinivasan
Name of Student : Vivekanandan M
Student’s Registration Number : GPBL-B/F10/15
Date of Submission : Dec 05, 2010
Word Count : 2192 words
Word Limit : 2000 words

2. ii
Checklist
Students Name Vivekanandan M
Registration Number GPBL-B/F10/15
Date of submission of the Assignment
01/12/2010
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All references material has been cited from the books & the
Universityof Wales online library. Any other internet source
quoted is with the permission of the module tutor.
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the “Guidelines to Writing Assignments”
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Declaration:
All material written in this assignment is my own and I have not used any material, content or
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___________________
Signature of the student Date: 05/12/2010

3. iii
TABLE OF CONTENTS PAGE No.
List of Tables 1
Introduction 2
Answer-1 2
Answer-2 4
Answer-3 5
Answer-4 5
Answer-5 7
Answer-6 8
Answer-7 8
Bibliography 10

4. 1
LIST OF TABLES PAGE No.
Table 1 - Computation of percentage change in # CAD/ 1
USD
3
Table 2 – Computation of profit margin during 2005, because
of exchange rate movement
3

5. 2
Introduction
This case study is about hedging foreign currency exchange rate risk. Assessing transaction
exposure and comparing hedging techniques to effectively manage unwanted exposure.
This report presents the solution and recommendation for the questions asked as part of the
case study.
Answer-1: Calculate percentage change in # CAD/USD exchange rate between the order
month and the invoice month for all transactions. USD cost difference per transaction
between the estimate used by Packmore and the invoice paid by Scott. Effect of
exchange rate movement on profit margin during 2005.
Order Date Spot Rate used at time of
order #of CAD/ 1 US
Absolute value
of Appreciation
Annualised value of
appreciation in %
Jan-04 1.33 0.75188 9.022556
Feb-04 1.34 -2.23881 -26.8657
Mar-04 1.31 4.580153 54.96183
Apr-04 1.37 -0.72993 -8.75912
May-04 1.36 -0.73529 -8.82353
Jun-04 1.35 -1.48148 -17.7778
Jul-04 1.33 -0.75188 -9.02256
Aug-04 1.32 -3.78788 -45.4545
Sep-04 1.27 -3.93701 -47.2441
Oct-04 1.22 -2.45902 -29.5082
Nov-04 1.19 0.840336 10.08403
Dec-04 1.2 3.333333 40
Jan-05 1.24 0 0
Feb-05 1.24 -1.6129 -19.3548
Mar-05 1.22 3.278689 39.34426
Apr-05 1.26 0 0
May-05 1.26 -2.38095 -28.5714
Jun-05 1.23 -0.81301 -9.7561
Jul-05 1.22 -2.45902 -29.5082
Aug-05 1.19 -1.68067 -20.1681
Sep-05 1.17 0.854701 10.25641
Oct-05 1.18 -0.84746 -10.1695
Nov-05 1.17 0 0
Dec-05 1.17
Table 1: Computation of percentage change in # CAD/ 1 USD

6. 3
Table-1 shows the percentage change in # CAD/USD exchange rate between the order month
and the invoice month for the years 2004 and 2005. During 2004, CAD has appreciated
against USD and a similar trend followed during the year 2005.
Exhibit-1 Exhibit-2 Gain/Liability
Order Date Cost Estimate
at time of
Order US $
(thousands)
Payment Month Invoice Paid in US $
(thousands)
Gain Liability
Jan-05 $213.90 Apr-05 $210.50 $3.40
Feb-05 $219.40 May-05 $215.91 $3.49
Mar-05 $197.66 Jun-05 $196.05 $1.61
Apr-05 $203.43 Jul-05 $210.10 ($6.67)
May-05 $224.96 Aug-05 $238.19 ($13.23)
Jun-05 $264.35 Sep-05 $277.91 ($13.56)
Jul-05 $254.38 Oct-05 $263.00 ($8.62)
Aug-05 $252.28 Nov-05 $256.59 ($4.31)
Sep-05 $252.26 Dec-05 $252.26 $0.00
Oct-05 $242.47 - -
Nov-05 $269.41 - -
Dec-05 $256.41 - -
Total $8.50 ($46.39)
Net ($37.89)
Table 2: Computation of profit margin during 2005, because of exchange rate
movement
As shown in Table-2, during the year 2005, due of appreciation of USD against CAD for the
first 3 months, St. Louis Chemicals paid less amount (than the order amount) to Norcand
Chemical. Thus the profit margin for St. Louis Chemicals for the first 3 months will be
greater than the projected profit margin for the first 3 months.
From April 2005, the USD started depreciating against CAD, which made St. Louis
Chemicals pay more amount (than the order amount) to Norcand Chemical. St. Louis
Chemicals paid USD 37890 more to Norcand Chemical during the year 2005, because of
exchange rate fluctuation. Exchange rate fluctuation during 2005 has decreased the profit of
St. Louis Chemicals by USD 37890. With increased sales and decreased profit, profit margin
for the current financial year will be less when compared to the previous financial year.
Less profit shall lead to decrease in the stock price of the firm and less valuation of the firm.

7. 4
Answer-2: For Dec-2005 order, determine the distribution of the USD cost to St. Louis
Chemical in Mar-2006.
Dec-2005 spot rate is 1.17 CAD/USD. The percentage change in CAD/USD (indirect quote)
exchange rate follows a normal distribution. Expected percentage change between the spot
rate in 90 days and the current spot rate is 0%, but the 90 days standard deviation in the
percentage change between the spot rate in 90 days and the current spot rate is equal to 4%.
a) Probability distribution for  variance
The probability of CAD reaching 1.17 for 1 USD with variance is given by,
P(68.4%) = 
= 0 4%
 1.17 0.0468
(i.e) 1.1232 to 1.2168
So the distribution of USD cost to St. Louis Chemical is, between 300000/1.1232
and 300000/1.2168.
(i.e) between USD 246548 to USD 267094
So the maximum loss that could be incurred by St. Louis Chemical because of
exchange rate fluctuation is (267094 – 256410) = USD 10683
b) Probability distribution for 80% confident level
The probability of CAD reaching 1.17 for 1 USD at 80% confidence level is given
by,
P(80%) = 
= 0 4%
= 0 
 1.17 0.0512
(i.e) 1.1188 to 1.2212
So the distribution of USD cost to St. Louis Chemical is, between 300000/1.1188
and 300000/1.2212.
(i.e) between USD 245660 to USD 268144
So the maximum loss that could be incurred by St. Louis Chemical because of
exchange rate risk is (268144 – 256410) = USD 11734

8. 5
Answer-3: Discuss with Williams the extent of exchange rate risk faced by St. Louis
Chemical arising from the Dec-2005 order transaction (CAD 300000) using a 90-day
Value-at-Risk methodology based on a 95% confidence level.
Dec-2005 spot rate (indirect quote) is 1.17 CAD/USD. The Dec-2005 order is expected to
cost USD 256410 in 90 days. Maximum loss is determined by the lower boundary of the
probability distribution. The percentage change in CAD/USD (indirect quote) exchange rate
is assumed to follow normal distribution. The expected percentage change between the spot
rate in 90 days and the current spot rate is assumed to be 0%, but the 90 day standard
deviation in the percentage change between the spot rate in 90 days and the current spot rate
is assumed to be equal to 4%.
a) Probability distribution for 95% confident level
The probability of CAD reaching 1.17 for 1 USD at 95% confidence level is given
by,
P(95%) = 
= 0 4% * 1.1.7)
= 0 
 1.17 0.07722
(i.e) 1.09278 to 1.24722
So the maximum loss to St. Louis Chemical is,
= 300000/1.09278 - 300000/1.17
= 274529 – 256410
= USD 18119
The maximum loss that could be incurred by St. Louis Chemical for Dec-2005 order
payment due to exchange rate exposure risk is USD 18119
Answer-4: Strengths and weakness of paying Norcand at the time of delivery rather
than waiting 60 days until the invoice is due.
a) Probability distribution for 95% confident level
The payment time is reduced to 60 days. So the variance for 60 days is,
8 / Square root (6) = 3.266
The probability of CAD reaching 1.17 for 1 USD at 95% confidence level is given
by,
P(95%) = 
= 0 3.266%)

9. 6
= 0 
 1.17 
(i.e) 1.116111 to 1.223889
So the maximum loss to St. Louis Chemical is,
= 300000/1.116111 - 300000/1.17
= 268790 – 256410
= USD 12380
This shows that reduction in the payment time to 60 day also decreases the maximum
loss that could be incurred by St. Louis Chemical. [Maximum loss for 90 day payment
period is shown in Answer-3].
Strengths of paying Norcand at the time of delivery rather than waiting 60 days until
the invoice are due:
 Both St. Louis Chemicals and Norcand will have only 30 days exchange rate exposure
risk or transaction risk instead of 90 days exposure.
 If St. Louis Chemicals have a good forecasting system to forecast the exchange rate
and if the system predicts that CAD will appreciate, then St. Louis Chemicals can
borrow money from Bank and immediately pay the amount to Norcand.
 Working capital for Nocand will decrease.
Weakness of paying Norcand at the time of delivery rather than waiting 60 days until
the invoice is due:
 There will be variation in accounts payable/invoice raised for the buyer - St. Louis
Chemicals.
 There will be variation in accounts receivable/quotation for the seller - Norcand.
 Both the company’s profit margin and balance sheet will have some variation.
 Working capital for St. Louis Chemicals will increase.
 The cash flow for the firm will be affected because of risk that arise due to an
unexpected change in exchange rate

10. 7
Answer-5:
Money Market Hedge – Money market hedging is a hedging technique to minimise or
eliminate the financial risk due to exchange rate fluctuation. Money market hedge involves
taking a money market position to cover a future payable or receivable position.
In Money Market Hedge on Payables, MNC can create a short term deposit in foreign
currency that it will need in the future. Even if MNC does not have excess cash, it can use
money market hedge to hedge payables.
In Money Market Hedge on Receivables, the MNC that expects receivables in a foreign
currency, it can hedge this position by borrowing the currency now and converting it to USD.
The receivables will be used to pay off this loan.
St. Louis Chemicals can follow the following money market hedging technique to eliminate
the risk associated with Dec 2005 order valued at CAD 300,000. The spot rate is 1.17
CAD/USD. St. Louis Chemicals can borrow USD for 3 months at an annual rate of 7.25%.
St. Louis Chemicals can earn an annual rate of 2% on a 3 month CAD time deposit for
transaction below one million.
If 1 CAD is invested in bank at 2% interest rate, after 3 months it will become
CAD 1.005
So, to get CAD 300,000 after 3 months, St. Louis Chemicals should invest CAD
300000/1.005 = 298507 in Canadian bank for an interest of 2%.
CAD 298507 is equivalent to USD 298507/1.17 = 255134. So, St. Louis Chemicals
should have excess cash of USD 255134, to be invested in the Canadian Bank. This
will increase the working capital requirement for St. Louis Chemicals, which will
have additional cost associated with it, which will erode the profit margin.
If St. Louis Chemicals does not have excess cash of USD 255134, then it should
borrow USD 255134 (1 + 0.0725/4) = 259758 from the bank. So USD 259758 will be
equivalent to CAD 300000. Thus St. Louis Chemicals spend USD 4624 for
eliminating exchange rate risk for the repayment of Dec-2005 order. So, there will be
a decrease in the profit margin by USD 4624.

11. 8
Answer-6:
Forward Rate Hedge – Forward hedge is also a hedging technique to minimise or eliminate
the financial risk due to exchange rate fluctuation. In this technique, Multi National
Corporation (MNC) enters a contract with a commercial bank either to buy or sell a currency
in future, but locks the exchange rate while entering the contract. This is similar to
futures/options contracts. Forward rates are available only for Euro, British Pound, Canadian
Dollar and Japanese Yen for 1-month, 3-month, 6-month and 12-month maturities.
St. Louis Chemicals can follow forward rate hedging to eliminate the risk associated with
Dec 2005 order valued at CAD 300,000. The spot rate is 1.17 CAD/USD. A 3 month forward
rate (indirect quote) at the time of the order is quoted at a bid price of 1.1590 CAD/USD and
an ask price of 1.16 CAD/USD for a transactions valued at one million USD or more.
Since St. Louis Chemicals repayment amount is less than one million, so St. Louis
Chemicals cannot use forward rate hedge for Dec 2005 order.
Answer-7: Recommendations to Williams regarding the exchange rate risk faced by St.
Louis Chemicals
Currently St. Louis Chemicals is paying in CAD, while the local currency is USD. The
difference in date of order and date of payment is 90 days. So St. Louis Chemicals is exposed
to the following 2 types of risks, in addition to economic risk.
a) Transaction risk – fluctuation in exchange rate between the date of order and date of
payment
b) Translation risk – risk of variation of the value of assert and liabilities denominated in
foreign currency.
Following are some of the techniques to manage transaction risk,
1. Invoicing - St. Louis Chemicals can request Norcand to invoice the amount in USD.
2. Leading - St. Louis Chemicals should have proper forecasting techniques to forecast
the exchange rate. If the forecast is, CAD will appreciate, and then St. Louis
Chemicals should borrow money from the bank and immediately pay to Norcand.

12. 9
3. Money Market Hedge – St. Louis Chemicals can create a short term deposit in CAD
currency that it will need in the future. If St. Louis Chemicals does not have excess
cash, then it can use money market hedge to hedge payables.
4. Forward rate hedge - St. Louis Chemicals can enter a contract with a Citibank NA to
buy CAD currency in future - 1-month, 3-month, 6-month and 12-month maturities.
5. Currency Option Hedge – Forward hedge and money market hedge can backfire
when the payable currency depreciates or a receivable currency appreciates over the
hedged period. Currency future contracts are contracts specifying a standard volume
of a particular currency to be exchanged on a specific settlement date.
St. Louis Chemicals can buy currency call option for CAD and the amount related to
payables.
6. Forward Hedge - St. Louis Chemicals can negotiate a forward contract to purchase
the amount of CAD needed to cover the payables.
7. Futures Hedge - St. Louis Chemicals can purchase currency future contract for CAD
and the amount related to the payables.
8. Currency swap - St. Louis Chemicals can do a currency swap with Norcand, if
Norcand has borrowed some loan in USD.

13. 10
Bibliography
1. Jeff Madura, International Corporate Finance, 8th
Edition
2. Prakash G Apte, International Finance, 2nd
Edition