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Merrill case final

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Merrill case final

  1. 1. Multinational Finance Management„The Merrill Case‟Presentation by: Yu Zhang, Juan LeonSanchez, Francisco Magro Ruiz,Hongfeng Wu and Hasan SoylemezFebruary 22, 2013
  2. 2. 2IndexIntroductionProblemsSolutions and OptionsComparisonConclusion and Recommendation
  3. 3. 3Introduction• Merrill Electronics Cooperation (MEC) was founded in 1950 byThomas Merrill• After his death, Patricia Merrill inherited the 75 % of the sharecapital together with her mother• In 1984, MEC signed an agreement with Goldstone Corporation inTaiwan, which was a major producer of electronic devices• In mid-1980‟s, MEC entered the fast-growing market PC marketwhich was becoming more and more competitive each day• In 1989, it became a national distributor for Fuji Electronics• Yen-dominated purchases exceeded $ 20 million during the past 12months• Due to growing volume in the market, further Yen purchases wasforesaw
  4. 4. 4Problems• High volatility of the Japanese Yen• The payment problem: 90-day currency risk exposure (60days shipping + 30 days grace period of payment afterdelivery)• Average of 6.1¥/$ difference for a 3-month period withthe average spot rate of 130.83¥/$ (Exhibit 4)• Most of the equipment were imported from Japan• Further Yen purchases were foreseen• Most of the Japanese suppliers insisted on invoicing inYen• More sensitive to currency risk than competitors
  5. 5. 5Options• No-hedge• Lock-in exchange rate• Forward contract hedge• Money market hedge• Yen futures hedge• Options contract
  6. 6. 6OptionsHistorical Data and AnalysisScenariosPros and Cons
  7. 7. 7Options1221241261281301321341361381400 1 2 3 4 5 6 7 8 9 10 11 12*Exchange Rate Yen/USD• A trend of Yen appreciation against the USD with an averageannual rate of +10%.• High probability that the trend will prevail for the future.What does the historical data show and imply?*See Exhibit 4
  8. 8. 8OptionsSCENARIOSScenario 1Spot Rate ¥/$ remainssame124.6 ¥/$Scenario 2Yen Depreciates by 3%128.338 ¥/$Scenario 3Yen Appreciates by 3%120.862 ¥/$Assumptions:• Historical trend shows that the annual appreciation of ¥/$ wasapp. 10%• Therefore, appreciation/depreciation of ¥/$ would be app. +/-3%for 3 months• No-hedge: Continue buying Yen at the spot market each time apayment has to be made
  9. 9. 9Options - No-hedgeSCENARIOSScenario 1Spot Rate ¥/$ remainssame124.60 ¥/$Scenario 2Yen Depreciates by 3%128.34 ¥/$Scenario 3Yen Appreciates by 3%120.86 ¥/$$1,805,778¥225 million$1,753,183¥225 million$1,861,627¥225 million
  10. 10. 10Options - No-hedgePros ConsIf Yen depreciates, thecompany can gain fromlower cost of goodsIf Yen appreciates, thecompany may suffer fromhigher cost of goodsCosts almost nothing (Nopremiums, fees etc.)Exchange rates can notbe precisely predictedEasy to implement, noneed for specializedfinancial staffMarket conditions makeit harder to put soundexchange rate forecastsCompletely vulnerable tomarket volatilities
  11. 11. 11Options - Forward ContractForward contracts are agreements between two parties whichrequire delivery of one currency at a specified future date of aspecified amount of another currency.• Exchangerate fixedbetweenthe parties1st step• Time2nd step• Buy thecurrency atthe priceset in the1st step3rd step
  12. 12. 12Options - Forward ContractBID ASKSpot rate(Yen per USD)124.60 124.70Forward rate(Yen per USD)124.95 125.10BID: The rate at which bank sells YENASK: The rate at which bank buys YENThe company needs to buy YEN;¥225 million on the forward market:225,000,000 / 124.95 =
  13. 13. 13Options - Forward ContractSCENARIOSScenario 1Spot Rate ¥/$ remainssame124.60 ¥/$Scenario 2Yen Depreciates by 3%128.34 ¥/$Scenario 3Yen Appreciates by 3%120.86 ¥/$$1,805,778$1,800,720$1,753,183$1,800,720$1,861,627$1,800,720
  14. 14. 14Options - Forward ContractPros ConsNo internal costsYou are responsible tofulfill the contract andtied-upMinimize the risk of thecurrency operationsYou will be unable tobenefit from any positivemovements in the foreignexchange rateAmount and dateadapted to individualrequirementsIt can‟t be traded
  15. 15. 15Options - Money Market HedgeMerrill would buy the YEN at today‟s spot market and place itin a YEN time deposit or another YEN asset until the due date.Deposit Credit90-days Euroyen interest rates 4.3125 % p.a. 4.4375% p.a.90-days Eurodollar interest rates* 3.3750% p.a. 3.5000% p.a.Merrill‟s short term borrowing rate is 6.00% + 25 bpsTransactions:1-) The YEN amount needed to deposit in order to have 225M byOctober: 225,000,000 / (1+0.01078125) = ¥ 222,600,0932-) Borrow from the bank in USD (6.0025% / 4 = 1.500625%)3-) Convert the USD to YEN as of today:¥ 222,600,093 / 124.60 = $1,786,5184-) Time deposit the YEN until the payment date5-) Pay the bank back in USD, and the supplier in YEN;USD amount needed along with the interest:$ 1,786,518 * 1.01500625 = $ 1,813,327
  16. 16. 16Options - Money Market HedgeSCENARIOSScenario 1Spot Rate ¥/$ remainssame124.60 ¥/$Scenario 2Yen Depreciates by 3%128.34 ¥/$Scenario 3Yen Appreciates by 3%120.86 ¥/$$1,805,778$1,813,327$1,753,183$1,813,327$1,861,627$1,813,327
  17. 17. 17Options - Money Market HedgePros ConsHighly profitability if enoughcash availableHigh complexity ofcalculationNo exchange rate risk Volatility of money-marketsGenerate profits if loaninterest < deposit interestDealing with Japanesefinancial marketPossibility of short terminvestmentsLoan interest poseadditional costNo penalties for fastwithdrawingOpportunity costs mayoccur if USD appreciates
  18. 18. 18Options - Yen Future HedgeInternational Monetary Market (IMM) provided the data:$ per ¥100 ¥ per $1September yen futures (IMM) 0.8046 124.285December yen futures (IMM) 0.8036 124.440Other Data : Standard Future size = ¥ 12,5 million per contract Broker‟s fee = $1,500 per contract Total ¥225 million
  19. 19. 19Options - Yen Future HedgeCalculations: How much $ should pay for the futures contract?¥225,000,000 / 124.440 = $1,808,100 How much futures contracts should be needed?¥225,000,000 / 12,500,000 = 18 futures contracts How much should we pay for the Broker‟s Commission ?$1,500 * 18 contracts = $27,000So, the total cost of future contracts including commission is:$1,808,100 + $27,000 = $1,835,100
  20. 20. 20Options - Yen Future HedgeSCENARIOSScenario 1Spot Rate ¥/$ remainssame124.60 ¥/$Scenario 2Yen Depreciates by 3%128.34 ¥/$Scenario 3Yen Appreciates by 3%120.86 ¥/$$1,805,778$1,835,100$1,753,183$1,835,100$1,861,627$1,835,100
  21. 21. 21Options - Yen Future HedgePros ConsStandardized contracts No tailoring of individualneedsPossibility of trading Broker commissionSafe method Margin account isrequiredPossibility to reduceexchange rate risks
  22. 22. 22Options - Currency Option ContractThis contract gives the right but not the obligation to buy (call) or tosell (put) currency or some other asset within a specified periodand at a predetermined price.Types of currency options:“European”-type options“American”-type options
  23. 23. 23Options - Currency Option ContractOctober yen calloptions (IMM)$ per 100 ¥ ¥ per $Strike price 0.800 125Premium price 0.0170 5882.35Provided yenamount225 million ¥ 225 million ¥CALCULATIONS:- Buy call options = ¥225,000,000 x 0.008 = $1,800,000- Premium cost = ¥225,000,000 x 0.00017 = $ 38,250- Total cost = $1,800,000 + $ 38,250= $1,838,250
  24. 24. 24Options - Currency Option ContractSCENARIOSScenario 1Spot Rate ¥/$ remainssame124.60 ¥/$Scenario 2Yen Depreciates by 3%128.34 ¥/$Scenario 3Yen Appreciates by 3%120.86 ¥/$$1,805,778$1,838,250$1,753,183$1,838,250$1,861,627$1,838,250
  25. 25. 25Options - Currency Option ContractPros ConsNot obligatory All have an expirationdateHigh flexibility Pre-paid premiums andfeesUnexpected marketconditions only leads to aloss of the premiumBuying out of thecontract leads to a lossof the premium alreadypaid
  26. 26. 26ComparisonOptionsScenario 1Current SpotRate Remains theSame124.60 ¥/$Scenario 2Yen depreciatesby -3%128.34 ¥/$Scenario 3Yen appreciatesby +3%120.86 ¥/$Do Nothing - +52,595 USD -55,849 USDForward -5,058 USD -47,537 USD +60,907 USDMoney MarketHedge-7,548 USD -60,144 USD +48,301 USDFutures -29,322 USD -81,917 USD +26,527 USDCurrency Options - 32,472 USD -38,250 USD +23,377 USD
  27. 27. 27Conclusion and Recommendation1. Shall the trend of Yen appreciation against USD continue, the besthedging option is locking-in a forward rate agreement with thebank due to the potential gain compared to the other alternativesand easy format of implementation.1. On the other hand, shall Yen depreciate against USD, then simplydoing nothing would suffice and be the best hedging option.2. Options contracts should also be considered since they can benot exercised if Yen depreciates against USD. In such a case, onlythe commission would be lost.3. All in all, even the best option is highly dependent on the expectedexchange rate and an accurate prediction can never be made.
  28. 28. 28Thank you!

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