An assignment on case study and presentation on International Financial Management where mainly four things were studied 1) Arbitrage Oppurtunity 2) Exercising the put and call option 3) Sell or Keep 4) Risk of Expose

1. An Assignment
On
Case study

2. AnAssignment
On
Casestudy
Prepared for
Muhammad Enamul Haque
Assistant Professor
School of Business and Economics
United International University
Prepared by
Group: CHOTURBHOOj
FIN- 4322 (A)
School of Business & Economics
January 1, 2017
United International University

3. GROUP NAME: CHOTURBHOOj
Members Name ID
Md. Tanvir Hossain 111 131 027
Md. Osin Khan 111 131 393
Md. Ismail Hossen 111 131 394
Jaheda Alam 111 131 260

4. January 1, 2017
Muhammad Enamul Haque
Assistant Professor
School of Business and Economics
United International University - UIU
Subject: Submission of Assignment on case study.
Dear Sir,
We hereby submit you the assignment on case study”. While doing the assignment, we believe we have
been able to make an understanding of the subject matter and the important issues that were required to
obtain.
We tired our level best to make an applicable and feasible report so that it will be as effective as it was
expected to be. We consider providing any information or clarification if necessary.
We hope you will accept our report and kindly oblige.
Thank You
Yours Truly
On behalf of the group
__________________
Md. Tanvir Hossain
111 131 027

5. Acknowledgement
We would like to express our gratitude to everyone who supported us throughout the assignment. We are
thankful for their aspiring guidance, invaluably constructive criticism and friendly advice during the project
work. We are sincerely grateful to them for sharing their truthful and illuminating views on a number of
issues related to the project.
First and foremost, praises and thanks to Allah, the Almighty, for showering blessings throughout the
report and giving us enough strength and team work to complete our project work. We would like to thank
our course instructor, Muhammad Enamul Haque, Assistant Professor, School of Business and
Economics, United International University for the valuable guidance and advice. He inspired us greatly to
work hard on this project. His willingness to motive us contributed tremendously to our project. Also, we
would like to take this opportunity to thank our United International University for offering this course. It
gave us an opportunity to learn a great deal about management of financial intuition.
Honorable mention goes to our family and friends for their understanding and support in completing this
project. Without them, we would face many difficulties while doing this.

6. Table of Content
Topic Page No.
BLADE Inc. (Use of Currency Derivatives) 1-9
BLADE Inc. (Assessment of Arbitrage) 10-15
BLADE Inc. (To invest in Thailand) 16-19
BLADE Inc. (To invest in Thailand) 20-23

7. 1 | P a g e
BLADE Inc. (Use of Currency Derivatives)

8. 2 | P a g e
If Blades uses call options to hedge its yen payables, should it use the call option
with the exercise price of $0.00756 or the call option with the exercise price of
$0.00792? Describe the tradeoff.
Options
An option is a financial derivative that represents a contract sold by one party (the option
writer) to another party (the option holder). The contract offers the buyer the right, but not the
obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price
(the strike price) during a certain period of time or on a specific date (exercise date).
Exercise Price
The price per share at which the owner of a traded option is entitled to buy or sell the
underlying security.
Call Options
Call options give the option to buy at certain price, so the buyer would want the stock to go up.
Conversely, the option writer needs to provide the underlying shares in the event that the
stock's market price exceeds the strike due to the contractual obligation. An option writer who
sells a call option believes that the underlying stock's price will drop relative to the
option's strike price during the life of the option, as that is how he will reap maximum profit.
Call Premium
Call premium is the dollar amount over the par value of a callable fixed-income debt security
that is given to holders when the security is called by the issuer. 2. The amount the purchaser of
a call option must pay to the writer.
Put Option
Put options give the option to sell at a certain price, so the buyer would want the stock to go
down. The opposite is true for put option writers. For example, a put option buyer is bearish on
the underlying stock and believes its market price will fall below the specified strike price on or
before a specified date. On the other hand, an option writer who shorts a put option believes the
underlying stock's price will increase about a specified price on or before the expiration date.
Balde Incs has two options to purchase and now they need to make a decision on choosing one
of them. A recent event has caused an uncertainty in Yen’s future value. The Premium of the
Call Option with a price of $.00756 has changed to $.0001512. But now Balde Incs has new Call

9. 3 | P a g e
Option to choose which has premium of $.0001134 with an exercise price of $.00792. Now CFO
Ben Holt has given a condition which is “Blade Incs will not pay no more than 5% above the
existing spot rate for a transection 2 months beyond its order date, as long as the premium is no
more than 1.6%”
Based on the condition both of the above Call Option meets one requirement. If the company
goes with the call option with the exercise price of $.00756 than they have to pay a 5% above the
exercise price but the Premium paid will be higher than the given condition which is 2%. On the
other hand, the other Call option with an exercise price of $0.00792 has a premium of 1.43%
which is lower than 1.5% but the Exercise price is 10% that far exceeds the condition of paying
no more than 5%. Now it depends on the company whether it wants to pay a higher premium
or a high exercise price which will reduce the effectiveness of hedging. Now if it chooses to pay
a higher premium then it has to pay a premium of $1,890 so that it can limit the cost to $94,500.
If the company chooses to pay a higher exercise price than the company must pay a premium of
$1,417.5 to limit the cost to $99,000.
The company should pay the higher Premium as it lowers the ultimate cost of the Blade
Inc. Because the maximum loss is higher if the company goes for the lower premium. If we pay
a higher premium of ($1890-$1417.5) = $472.5 then we can avoid the maximum loss of $4500 in
the future.
Before
Event
After Event Difference
Yen Payable 12500000 12500000 12500000
Spot Rate $0.0072 $0.0072 $0.0072
Option Info
Exercise Price $0.00756 $0.00756 $0.00792 $0.00036
Exercise Price (% above spot) 5% 5% 10% 5%
Option Premium $0.0001134 $0.0001512 $0.0001134 $0.0000378
Option premium (% ofExercise
Price)
1.50% 2.00% 1.43% .057%
Total Premium $1417.5 $1890 $1417.5 $472.5
Amount to Be Paid $94500 $94500 $99000 $4500
Future Contract Info
Future Price $0.006912 $0.006912

10. 4 | P a g e
Should Blades allow its yen position to be unhedged? Describe the tradeoff.
Hedging
A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a
hedge consists of taking an offsetting position in a related security, such as a futures contract.
A perfect hedge is one that eliminates all risk in a position or portfolio. In other words, the
hedge is 100% inversely correlated to the vulnerable asset. This is more an ideal than a reality
on the ground, and even the hypothetical perfect hedge is not without cost.
Future Contract
A futures contract is a legal agreement, generally made on the trading floor of
a futures exchange, to buy or sell a particular commodity or financial instrument at a
predetermined price at a specified time in the future. Futures contracts are standardized to
facilitate trading on a futures exchange and, depending on the underlying asset being traded,
detail the quality and quantity of the commodity.
Now Blade Inc also wants to know what will be there position if they don’t go for any
types of hedging and waits to see what actually happens in the future under this uncertain
situation-
It would not be a wise idea to go unhedged under this uncertain situation. In the case the
company wanted to hedge due the fact that the Yen is a highly volatile currency which can
change any moment. Recently the uncertainty has increased further with a recent event. So
going unhedged might have negative effect on Blade Inc in two months and it might have to
pay a lot more than it has to pay if it hedges it payment. For example, if the currency
strengthens and the spot price in future becomes $0.009 than Blade Inc has to pay $112,500
which is $16,110 higher if it goes for Call Option 1 (Appendix 1. So it would be a wise idea to go
for hedging to prevent any further losses.
The best thing that Blade Inc needs to do is go for a Future Contract due to the fact that after the
occurrence the price of the Future Contract is similar to before. So Blade Inc should enter into a
future contract and lock the spot rate for future to minimize the losses.
Assume there are speculators who attempt to capitalize on their expectation of the
yen’s
Movement over the two months between the order and delivery dates by either
buying or selling yen futures now and buying or selling yen at the future spot rate.
Given this information, what is the expectation on the order date of the yen spot rate
by the delivery date? (Your answer should consist of one number.)

11. 5 | P a g e
Speculation
Speculation is the act of trading in an asset or conducting a financial transaction that has a
significant risk of losing most or all of the initial outlay with the expectation of a substantial
gain. With speculation, the risk of loss is more than offset by the possibility of a huge gain,
otherwise there would be very little motivation to speculate.
Spot Rate
The price quoted for immediate settlement on a commodity, a security or a currency. The spot
rate, also called “spot price,” is based on the value of an asset at the moment of the quote.
Speculators are present in the market and Blade Inc is concerned with what will happen
to future spot rate if the speculators try capitalize on the opportunities that may arise over the
two months’ period-
If the speculators capitalize on the opportunities that arise through speculation, then it can be
said that the future spot rate will equal to the given future price which is $.006912. Now if they
expect that in future the price of Yen to Appreciate then, they would buy yen futures now. If the
yen appreciates, they will buy the yen at the futures rate in two months and sell them at the
spot rate prevailing at that time. Thus, if the market expectation is that the yen will appreciate,
all speculators will engage in similar actions, which would place upward pressure on the
futures rate and downward pressure on the expected future spot rate. This process continues
until the futures rate is equal to the expected future spot rate. Therefore, the expected spot rate
at the delivery date is equal to the futures rate, $0.006912.
Assume that the firm shares the market consensus of the future yen spot rate. Given
this expectation and given that the firm makes a decision (i.e., option, futures
contract, remain unhedged) purely on a cost basis, what would be its optimal choice?
Blade has three option in hand first the company can remain unhedged, second, it can go for a
future contract and finally it can buy the call options. Now Blade wants to know which will be
the optimal choice if the decision is made on purely cost basis-
First of all, if they remain unhedged and share the market consensus of the future yen spot rate
than the maximum cost after two months for Blade Inc will be $86,400 however uncertainty still
remains due to the high volatility of the rate Yen. As mentioned before where the cost might
increase a lot. So it better not to go unhedged
Second, if they purchase call option with an exercise price of $.00756 than the total cost for Blade
inc will be $96,390. If Blade in purchases the Second call option with an exercise price of $.00792

12. 6 | P a g e
than the total cost for Blade Inc will be $100417.5 so if the choice is between this two than Call
Option 1 is preferable.
Finally, if Balde Inc goes for a future contract by locking the contract for two months at the
price of Future price expectation which is $.006912 then the total cost will be $86,400 and there is
no risk associated with it as we are prepare to pay the spot rate of $.006912. So even the spot
rate in future increases we can be safe from the loss that would have been occurred.
So, if the optimal choice is to be made based on purely cost than it is clear that going for
a future contract is the most suitable option for Blade Inc as it gives security from the
uncertainty as well as it a lower cost than any other options available in the market.
Will the choice you made as to the optimal hedging strategy in question 4 definitely
turn out to be the lowest-cost alternative in terms of actual costs incurred? Why or
why not?
Now, the hedging strategy was the optimal when we think purely on cost basis and consider
uncertainty as a future risk but what if the uncertainty is shifts in the favor of Blade Incs than
what will happen. Now Blade Inc wants to be sure if the Optimal Strategy for hedging made in
the last section was the best hedging strategy-
Yen has been considered as an uncertain and highly volatile currency and the recent event has
increased its volatility further nut the volatility can make it costlier or cheaper. So only if the
future spot price of becomes lower than the future price expectation which is $.006912 then the
company will incur the lowest cost by remaining unhedged. For example, if the future spot
price in two months becomes $.0066 then the total cost of Blade Inc. after two months will be
$82,500 which is $3,900 lower than the future contract. So if the firm goes into a future contract
and locks the price at which the firm will buy Yen after two months than Blade Inc. will lose
any opportunity to get any cost advantage from the volatility of the currency depreciation.
Under this circumstances buying an option or remaining unhedged might be a better option of
Blade Inc. as these two alternatives gives the flexibility to Blade Inc. on the time of delivery date.
In case of Options they can just pay the premium if the Spot rate has significantly depreciated
and buy the Yen at Spot rate from the market. When entered in to a future contract this
flexibility is vanished and Blade Inc. must purchase the contracted Yen on the specified spot
rate.

13. 7 | P a g e
Let’s look at different alternative with concerning uncertainty in mind
Remaining Unhedged
Expected Spot Rate $0.006912 $0.0066
Yen required 12,500,000 12,500,000
Total cost $86,400 $82,500
Going for a Future Contract
Future Spot Rate $0.006912
Yen required 12,500,000
Total cost $86,400
Buying Call Options
In case of call option there are things that first needed to be considered which are:
In the Money
In the money means that a call option's strike price is below the market price of the underlying
asset or that the strike price of a put option is above the market price of the underlying asset.
Being in the money does not mean you will profit, it just means the option is worth exercising.
This is because the option costs money to buy.
Out of the Money
Out of the money (OTM) is term used to describe a call option with a strike price that is higher
than the market price of the underlying asset, or a put option with a strike price that is lower
than the market price of the underlying asset.
At the Money
At the money is a situation where an option's strike price is identical to the price of
the underlying security. Both call and put options are simultaneously at the money.
Now based on the three scenarios described above for exercising the Call Options we
can say if the Future Spot Price is in consensus with the Future expectation then Blade Inc. Call
options will be out of the money and regardless of the fact Blade Inc. must pay the premium for
the Call Option purchased. A summary table showing the total cost that to incur is given
bellow:

14. 8 | P a g e
Exercise Price Premium Exercise Payment Total
Cost
Call Option 1 $0.00756 1,890 No $86,400 $88,290
Call Option 2 $0.00792 1,417.5 No $86,400 87,817.5
Now based on the above table it can be seen that when the Call option is not exercised as it is
lower than the higher than the spot rate. So Blade Inc. will prefer to pay using the future spot
price which is predicted to $0.006912 and then have to add the premium on the Call Option to
get the total cost hedging using the Options.
Now assume that you have determined that the historical standard deviation of the
yen is about$0.0005. Based on your assessment, you believe it is highly unlikely that
the future spot rate will be more than two standard deviations above the expected
spot rate by the delivery date. Also assume that the futures price remains at its
current level of $0.006912. Based on this expectation of the future spot rate, what is
the optimal hedge for the firm?
After researching the historical data, it has been found that the Standard Deviation for the Yen
is $0.0005 and the assessment has showed that the Spot Price in two-month period would be 2
Standard Deviation higher as a result the new Future Price is expected to be-
Expected Spot rate $0.006912
Standard Deviation $0.0005
Price will be 2 Standard Deviation Higher (2 X $0.0005)= $0.0010
New Spot Price $0.007912
With the Change in the Spot Price the scenario has changed now one of the Call Option is in the
money meaning we can exercise that Call Option as well has if Blade Inc. remain unhedged
than the cost will become substantially higher than before which makes it the riskiest strategy
and the most optimal strategy that can be followed now is the Future Contract which remains
unchanged as a result is the most cost effective Option under this circumstances. A summary of
the cost is given bellow for comparison.
Remain Unhedged
Expected Spot Rate $0.007912
Yen required 12,500,000
Total cost $98,900
Go for Future Contract

15. 9 | P a g e
Future Spot Rate $0.006912
Yen required 12,500,000
Total cost $86,400
Purchasing the Call Option
Exercise Price Premium Exercise Payment Total
Cost
Call Option 1 $0.00756 1,890 Yes $94,500 96,390
Call Option 2 $0.00792 1,417.5 No $98,900 100,317.5
So both of the Call option has a higher cost rate than the future contract. And in case of Call
Option 2, even though it was not exercised still it has the highest cost option for Blade Inc. So
the best Option for Blade Inc. under the given circumstances is going for a future contract for
hedging and minimizing lose that might occur after two months.

16. 10 | P a g e
BLADE Inc. (Assessment of Arbitrage)

17. 11 | P a g e
Case Synopsis:
Blades a US firm that manufactures the roller blades made a contract to sell 180000 Speedos annually
for next 3 years denominated in Thai Baht. However after entering into the contract the value of Thai
baht constantlywentdowninthe foreign exchange market as investor constantly withdrew fund from
Thailand due to the political risk. As a result, Blades’ net cash inflow from the Thai firm is expected to
face foreignexchange lossdue to the deterioration of the Thai baht in foreign exchange market which
will adversely affect the company. In this situation to minimize the loss, the CFO of Blades is trying to
analyze the informationregardingexchange rates of Thai baht in different locations as well as interest
rates of two countries to take any arbitrage opportunity possible.
Locational Arbitrage:
Locational arbitrage can occur when the spot rate of a given currency varies among
locations. Specifically, the ask rate at one location must be lower than the bid rate at another
location. The disparity in rates can occur since information is not always immediately available to all
banks. If a disparity does exist, locational arbitrage is possible; as it occurs, the spot rates among
locations should become realigned.
Since the bid rate at Minzu bank is lower than the ask rate at Sobat Bank locational arbitrage is not
possible byselling Thai Baht at Minzu Bank. However, the bid rate at Sobat Bank is higher than the Ask
rate at MinzuBank. So, locational arbitrage is possible here by selling Thai Baht at Sobat Bank because
investor can realize profit by buying Thai Baht at a cheaper rate at Minzu Bank and immediately by
selling them to Sobat Bank at a higher rate until realignment takes place. Therefore, the foreign
exchange quotations are inappropriate here.
Locational Arbitrage
MinzuBank Sobat Bank
Bid $
0.0224
$
0.0228
Ask $
0.0227
$
0.0229
Bid Rate greater than otherbank's
Ask rate?
No Yes
Locational Arbitrage Possible by
SellingThai Baht?
No Yes
Exchange Rate Differential 0 0.0001
InvestmentAmount 100000.00
Buy Thai Baht From MinzuBank 4405286.34

18. 12 | P a g e
Sell Thai Baht to Sobat Bank 100440.53
Arbitrage Profit 440.53
Rate Of Return 0.44%
For Example Blade Inc. can withdraw $100000 from its account and buy Thai Baht from Minzu Bank At
the ask rate of $0.0227. The converted amount would be TB 4405286.34 and immediately Blades Inc.
can sell the Thai Baht to Sobat bank at the ask rate of $0.0228, the reconverted amount will be
$100440.53. This indicates that Blade Inc. can make riskless profit of $440.53 without tying up the
investmentbyutilizingthe locational price discrepancy.ThisArbitrageOpportunitywill be availableuntil
market participants realign the discrepancy in exchange rate at the two banks.
Triangular Arbitrage:
Triangular arbitrage is possible when the actual cross exchange rate between two currencies differs
from what it should be. The appropriate cross rate can be determined given the values of the two
currencieswithrespecttosome othercurrency.Investors earnrisklessprofitwhen there is discrepancy
in quoted cross exchange rate and the implied (calculated) cross exchange rate.
Bid Rate Ask Rate
Value of Japanese Yenin USD 0.0085 0.0086
Value of Thai Baht in USD 0.0224 0.0227
Value Of Thai Baht in Japanese Yen
(Quoted)
2.69 2.7
Value Of Thai Baht in Japanese Yen
(Implied)
2.64 2.64
Trainagular Arbitrage Possible? Yes
Arbitrage Profit
InvestedAmount $100,000
Convertto Thai Baht 4405286.344
Sell Thai Baht to GetYen 11850220.26
ConvertYen to USD 100726.8722
Profit 726.8722467
Rate of Return 0.73%

19. 13 | P a g e
Since there is discrepancy in the quoted cross exchange rate and implied exchange rate the Cross
exchange rate isnot appropriate.BladesInc.cancapitalize onthe discrepancy by investing for example
$100,000 on Thai Baht and thencovertit to Japanese yen.Atlastthe Japanese Yenshouldbe converted
into USD and the arbitrage riskless profit would be around $727 which h is about .73% return on the
invested amount though the investment is not tied up here.
Covered Interest Arbitrage:
Coveredinterestarbitrage involvesthe short-terminvestmentin a foreign currency that is covered by a
forward contract to sell that currency when the investment matures. Covered interest arbitrage is
plausible when the forward premium does not reflect the interest rate differential between two
countriesspecifiedbythe interestrate parity formula. If transactions costs or other considerations are
involved,the excessprofitfromcoveredinterestarbitrage mustmore thanoffsetthese otherconsidera-
tions for covered interest arbitrage to be plausible.
Covered Interest Arbitrage
Spot Rate $ Investment Amount $100000
USD
Thai BahtJapanese
Yen
Convert$100000 to Thai
Baht= THB 4405286.344
Exchange Thai Baht to get
Japanese Yen = ¥ 11850220.26
ConvertJapanese YenintoUSD
= $100726.8722.
Making Arbitrage Profit of
$726.87 (0.73%)

20. 14 | P a g e
0.0227
90 Day Forward Rate $
0.0225
Convert USD to Thai Baht THB
4405286.3
44
US 90 Day Interest Rate 2% Investment Value after 90 day THB
4570484.5
81
Thailand 90 Day Interest
Rate
3.75% ConvertThai Baht Investment Into
USD (forward contract)
$
102,835.90
Rate of Return 2.84%
Excess Return 0.84%
Since there isdiscrepancyinthe interestrate of USA and Thailandinvestorwill lookforCoveredInterest
Arbitrage.However,anappropriate forwarddiscountonThai bahtwouldoffsetthe extra return on Thai
Baht denominatedinvestment.Buthere the $0.0002 forwarddiscountisnot sufficient enough to offset
the gain frominterestrate discrepancy.Asaresultcoveredinterestrate arbitrage ispossible as forward
rate is not priced appropriately.
To showit innumbers suppose Blade Inc. invest $100000 in a Thailand bank and at the same time goes
for a forward contract to sale at $0.0225 forward rate. After 90 days the invested value would become
THB 4570484.581, if converted using the forward contract it would be $102,835.90. So the Total rate of
returnwouldbe 2.84% fromThai Baht denominatedinvestmentwhereasif investedinthe home Blades
Inc. wouldgeta returnof 2%. So an Excessreturnof .84% is possible from the interest rate discrepancy
until the realignment raises the forward discount to make the excess return to zero.

21. 15 | P a g e
Because of market forces arbitrage opportunities are likely to disappear soon after they have been
discovered. Supplyanddemandforthe foreigncurrencyadjustuntil the mispricing disappears as to the
arbitrageurstake actionto realize arbitrage profit.Forexample, since arbitragers will want to gain from
covered interest arbitrage, an immediate purchase and subsequent sale of Thai baht by them would
place upward pressure on the spot rate of the Thai baht and downward pressure on the Thai baht
forwardrate until coveredinterestarbitrage isnolongerpossible.Atthat point, interest rate parity will
exist, and the forward premium or discount will offset interest rate differential between the two
countries. There is no possibility of gaining from covered interest arbitrage at the point where the
interestrate parityexists because the interestrate differentialsbetweentwocountries is exactly equal
to the forward premium or discount.
-6%
-4%
-2%
0%
2%
4%
6%
-6% -4% -2% 0% 2% 4% 6%
Interst Rate Parity
InterestRate Differential (H-F)
Forward
Disount
Forward
Premium

22. 16 | P a g e
BLADE Inc. (To invest in Thailand)

23. 17 | P a g e
Assessment of Exchange Rate Exposure
Blades Inc. is exporting roller blades to Thailand and to jogs ltd. a British retailer. Blades Inc. is
importing its certain components needed to manufacture roller blades from Thailand and
Japanese supplier. The expansion of business would increase blades exposure to exchange rate
fluctuations here we assess how the contemplated changes would affect blades financial
position.
Facing the Exposure
Blades is subject to economic and transaction exposure. However, it is not subject to translation
exposure. Under economic exposure, Blades present value of its future cash flows is influenced
by changes in exchange rates. Under transaction exposure, Blades value of future cash
transactions is also influenced by changes in exchange rates. Under translation exposure, there
was no exposure of a MNCs “consolidate financial statements” with changes in exchange rates.
Cash flow
Currency Total
Inflow
Total
Outflow
Net Flow Expected Exchange
Rate
Net Flow (USD)
British Pound
Inflow
(200,000 x 80)
16,000,000 16,000,000
Inflow
$1.5 $24,000,000
Inflow
Japanese Yen
Outflow
(1,700 x 7,440)
12,648,000 12,648,000
Outflow
$.0083 $104,978.4
Outflow
Thai Baht Inflow
(180,000 x 4,594)
Thai Baht Outflow
(72,000 x 2,871)
826,920,000 206,712,000 620,208,000
Inflow
$.024 $14,884,992
Inflow

24. 18 | P a g e
Estimation of the range of net inflows and outflows
Currency Net Inflow or
Outflow
Range ofExchange
Rate
Range ofNet Inflows or
Outflows (USD)
British Pound 16,000,000
Inflow Inflow
Japanese Yen 12,648,000
Outflow Outflow
Thai Bah 620,208,000
Inflow Inflow
Reducing Transaction Exposure
If Blades does not enter into the agreement with the British firm but continues to export to
Thailand and import from Thailand and Japan, the increased correlations between the Japanese
yen and the Thai baht will reduce Blades level of transaction exposure. This is due to that fact
that Blades generates its net inflows in Thai baht and it generates its net outflows in Japanese
yen.
Reducing Net Transaction
We don’t think that Blades should import components from Japan to reduce its net transaction
exposure in the long run. The correlation between Thailand’s and Japans currency in relatively
unstable. Since Blades decreases its net transaction exposure from importing from Japan
(because of high correlation), we believe that Blades net transaction exposure will soon increase.
Overall Transaction Exposure
If blades enters into agreement with jogs ltd. its overall level of transaction exposure would
increase blades net cash inflows denominated in foreign currencies .However the increase in
transaction exposure is probably not too high, since the correlations between the two Asian
currencies and the British pound are relatively low.

25. 19 | P a g e
Depreciation of the Currency
Blades’ U.S. sales were likely negatively affected by the depreciation of the baht. U.S customers
have been buying foreign roller blades because they are cheaper “with a strengthened dollar”.
This resulted in Thailand manufacturers targeting the U.S roller blade industry. We believe that
Blades exports to Thailand would be affected negatively by the depreciation. We also believe
that Blades imports from Thailand would be affected positively by a depreciation of the baht.
As previously discussed, the correlation between Thailand’s currency and Japans currency has
been high; we feel the yen would also depreciate. In the end this would result to a reduced
dollar costs for Blades to pay for Japanese imports.

26. 20 | P a g e
ZAPA Chemical & BuBA

27. 21 | P a g e
CASE SYNOPSIS
The case deals with the foreign exchange exposure management of a US firm called ZAPA Chemical
which actually got the exposure when it sold a specialty chemical distributorship to a German firm in
mid-August.ZAPA isabouttoreceive DM7.6million as the sale proceeds in December. The volatility of
exchange rate of Deutsche Mark against US Dollar was quite high which made Stephanie, the currency
analyst of ZAPA’s Treasury to fall in hesitation to select the optimal hedging decision. The Treasury of
ZAPA is considered as a cost center and it follows a conservative approach towards exposure
management. The DMhave been appreciating since march to the end of august as the central bank of
Germanywas raisinginterestrate tostopinflationandtoslowdownmonetarygrowth.Inmid of August
Stephanie purchased an out of the money put option to hedge against the adverse movement of the
exchange rate. However the in September Buba cut the interest rate and several European countries
withdrew themselves from European Monetary system, which in turn made the DM to depreciate
against USD. The Put option was heading towards becoming in the money and the price of the option
was becominghigher.Now inthis situation Stephanie had to make decision whether ZAPA should sell
the put option and buy a forward contract to Lock its position or hold the put option to hedge against
adverse movement of exchange rate and benefit from the favorable one.
Whether Stephanie Mayoshouldsell the put optionprotectionalready inplace
or not?
Zapa Chemical hadbeeninindecisiontomanage exposure asDMwas volatile overthe period.US Dollar
Value against DMwas all-time low DM1.39/$ on Sep 1. Then US dollar appreciated to DM1.51/$ on Sep
16. Volatility is expected to be still high due to the rapid change of economic policies by BuBa and the
European countries.
In this situation the Sale of put option would expose ZAPA to adverse exchange rate movements. The
repatriationisexpectedtobe inDecemberwhichisstill 3 months later. Increased option value reflects
favorable exchange rate movement, but at the same time it also indicates increased volatility or risk.
Therefore,the possiblesolutiontoavoidexposure istosell putoptionprotectionandenterintoforward
agreement.

28. 22 | P a g e
To illustrate it further let us compare the outcomes of the two strategies at the settlement date:
USD Inflow on December 16 (in Thousands)
SpotRate DM1.5152 DM1.4000 DM1.3000
Strategy
1. Hold the Put Option Protection 5015.84 5428.57 5846.15
2. Sell Put Optionand Enter intoa Forward Contract 5131.40 5131.40 5131.40
o. 5
From the table we can see that the sale of put option & forward hedge (at DM1.5255/$) will lead to
higher outcome than option hedge in the worst case as well as at the current spot rate. However, the
forwardhedge doesnotallowbenefitingfromfurtherdepreciationof USdollar.Since Zapa’s policy is to
minimize the cost instead of gaining speculative return the second option would be the optimum
decision for Stephanie to take.
How have the events of September altered Stephanie’s view of the DM/$
exchange rate?
At Initial point,Stephanie expectedthe dollar to fall further since Buba was driving interest rates up to
slow monetary growth and stop inflationary forces. The interest rate differential was 6.438% (US:
3.3125%; Germany: 9.750%). It seemed like Stephanie was right at that time but the September
turbulence had turned the momentum to other way round.
 The uncertainty in Europe due to French vote on Maastricht Treaty
 Stress in the EMS (devaluation pressure on LIT and GBP)
 Withdrawal of GBP and LIT from ERM
 Cut of lending rate by Bundesbank

29. 23 | P a g e
 5% devaluation of Spanish peseta
All this events made the foreign Currency market to more volatile in both ways. As a result the dollar
had fallen, risen, and fallen again. The value of the put option purchased had been increasing
substantially. Consequently, she wished to reassess her put option position that she took in august.
How has the volatility of the put option changed between August and
September?
The volatility of the out of the money put option has increased due to the rapid change of spot rate of
USD against DM. In August, premium moved between $0.5 and $1.50 per DM. In September premium
fluctuated between $0.5 and $2.50 per DM which indicates that the value of the OTMput option was
immensely volatile.
It is clearly visible on the graph that the option premium moved along with the exchange rate of DM
againstUSD. Since the put optionwas out of the money,the decline of USD value against the DMmade
the put premiumtogo downfrom mid-August to late August. However as soon as the USD was getting
strongeragainstDM throughthe Firstthree weekof September the Put premium increased quite a lot
as the difference betweenthe strike price and spot rate was getting decreased and the put option was
heading toward in the money position.

30. 24 | P a g e
What benchmarks would you use to measure the hedging effectiveness? How
would this alter Stephanie’s hedging?
Since ZAPA considersTreasurya cost centerratherthan a profitcenter,Treasuryissupposedto follow a
conservative management of exposure which is the primary responsibility of Treasury. However, the
managementwasappreciativeif the expensesof runningthe costcenterwere lower. Therefore Cost as
a benchmarkto measure hedgingeffectiveness should be used that is to maximize the expected value
but giving more priority to minimize the variance or risk. Since forward contracts caused losses in the
past, Foreign Exchange Options was preferred by Stephanie. If the put option was sold and forward
contract was signed Zapa could locked it position to $5.13 Million inflow instead of looking for
speculative return from USD’s depreciation against DM. Therefore if we were in the position of
Stephanie, we should have preferred cheaper and less speculative forward hedge to follow the
conservative approach to risk management.
4000.00
4200.00
4400.00
4600.00
4800.00
5000.00
5200.00
5400.00
5600.00
5800.00
6000.00
1.4000
1.4100
1.4200
1.4300
1.4400
1.4500
1.4600
1.4700
1.4800
1.4900
1.5000
1.5100
1.5200
1.5300
1.5400
1.5500
1.5600
1.5700
1.5800
1.5900
1.6000
CashInflow(inThousnads$)
Spot Rate
Unhedged
Position
Put Option
Forward
Contract