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Merton Electronics Currency Risk

In: Business and Management

Submitted By DNArmstrong
Words 1279
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1. What is the currency risk exposure facing Merton? What dimension is more relevant in the case of Merton: transaction exposure, translation exposure, or economic exposure?
Merton Electronics is a company in the United States that imports from both Japanese and Taiwanese suppliers, to then be distributed nationally. Both suppliers invoice in their local currencies (Japanese Yen and Taiwanese Dollars, respectively). The mechanics of payments are as follows: Merton places an order, and the Asian supplier ships within 60 days. Payments are done 30 days from the end of the delivery month, but the spot price on the last day of the month in which the order is placed is used for the invoice.
In other words, Merton faces a 90-day transaction exposure for each order, which also seems to be the most relevant dimension. Indeed, there does not seem to be obvious translation exposure since this is not an issue of accounting differences. Merton’s competitive position is somewhat affected by this currency risk, but this economic exposure seems of second order compared to the transaction exposure described in the case. 2. In the situation facing Merton Electronics, should currency risk be hedged? Why?
Yes. First, the company is family-owned and nothing in the case seems to indicate that the Merton family was able (or willing) to diversify its portfolio internationally.
Second, Merton Electronics relies on its cash-flows to finance its future investments in new computers, office equipment and fixed assets. Unhedged currency risks could jeopardize and/or force to postpone these investments, thus damaging the value of the company. 3. How much would you hedge?
A quantitative hedging optimization would require us to estimate the optimal hedge ratio. To calculate the optimum hedge ratio we would need to have figures for the standard deviation of the spot and future...

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