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Possible Solution

In: Business and Management

Submitted By lebronniu
Words 943
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Possible Solutions
The first possible solution would be to conduct the transaction without hedging, as with the previous order. The forecasted bid rate for September 5, 2006 is US 0.4234. If this forecast holds, the amount of the receivable would total $66,265. Since no Weighted Average Cost of Capital was given, we decided to use the effective rate on Baker Adhesives’ domestic line of credit as the discount rate. The annual percentage rate of the line of credit is 8.52%, and the effective 3 month rate comes to 2.1452%, factoring in compounding. After discounting to net present value for comparison purposes the receivable would total $64,874. The profit margin for this method, assuming the forecast to be correct, is 2.0%. This solution imposes a great amount of risk. The current year-to-date standard deviation of monthly exchange-rate changes is 6.53%, meaning that the actual amount that Baker Adhesives will receive could vary greatly. The break-even exchange rate, or the lowest rate at which the receivable would cover the total cost of the order, is US 0.4152. Since this break-even exchange rate falls within one standard deviation of the forecasted bid rate, it poses a threat that the company could realize a loss with the sale if the Brazilian Real depreciated below the break-even rate, however; there is also the potential that the company could obtain a higher profit margin if the Brazilian Real unexpectedly appreciated against the US dollar as opposed to depreciating. Obtaining the company’s desired profit margin of 8% would require a minimum exchange rate of US 0.4512, which also falls within one standard deviation above the forecast.
The next possible solution would be to hedge the transaction in the money market. The first step for this process is to determine the amount the company would need to borrow in Brazilian Real. The annual percentage rate being

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