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EXECUTIVE SUMMARY

This report focuses on the financial decision-making by USASuperCars that sells

luxury sports car. The company has signed a contract to deliver a specific number of

cars to different customers worldwide. The report first finds out the mean of an

uncertain revenue along with the standard deviation of total revenue. The report also

finds out the financial risks faced by USASuperCars. Then, the decision is made on

whether the sure sum to be received by USASuperCars from HSBC Bank is

financially beneficial or risky. It should also be noted that there is an uncertainty in

the exchange rates and therefore, the revenue will vary which depends on the

exchange rate variations either positive or negative. Nevertheless, USASuperCars’s

expected return is more than the sure sum but this can be a better option for the

company as the exchange rate risks are unpredictable. It costs them 1.95% to

accept the sure sum offer. I think that the sure sum offer can be the better option for

them since they do not have to pay any interest expense. But if the exchange rate is

the same as the prevailing one then the USA supercars will bear a loss of $44683.2.

This analysis is done throughout the report and then the conclusion is made at the

end of the report confirming my opinion about that.

USASUPERCARS 2

Table of Contents

EXECUTIVE SUMMARY...................................................................................................................1

INTRODUCTION................................................................................................................................3

DEMAND AND SUPPLY OF LUXURIOUS CARS........................................................................3

EXCHANGE RATE UNCERTAINTY...............................................................................................4

DATA ANALYSIS...............................................................................................................................5

CONCLUSION....................................................................................................................................7

BIBLIOGRAPHY................................................................................................................................9

APPENDICES...................................................................................................................................10

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INTRODUCTION

In today’s world, the production and consumption of goods has attained the global

status (IISD, 2009). This means that the goods are purchased and consumed by

international customers. This is the reason why such companies are making

relentless efforts to promote their products, services and brands. They find different

ways to lower the cost of sales in order to increase the gross profit that is highly

recommended to be favourable for any company. However, there is a risk for such

multinational companies which is specified by the name of exchange rate risk .If the

exchange rate goes down then there is a need to either put a quota on the number of

goods being exported or stop the exporting of goods. Therefore, it can be said that

the fluctuation in an exchange rate can either increase profits or result in losses.

Moreover, if the $ weakens against other currencies then this will cause the profits of

the deposited money to decline in accordance with other currencies. That is why

hedging is a necessary strategy which lowers the possible risk of losing the value of

invested or deposited money. Hedging involves purchasing forward contracts,

participating in foreign currency swaps, exchanging local currency with foreign

currency and buying of spot contracts (Knight, 2012). Apart from that, foreign

exchange risk can also be avoided by opening accounts in different banks worldwide

where the receivables are paid in the same currency (Reed, 2012). There should be

another option for the manufacturing companies to transfer the base of manufacturer

so that the revenue is received in the similar currency (Anon., 2010). This is the best

possible alternative to avoid exchange rate currency risk. These ways will prevent

the company from exchange rate risk. Moreover, the spot contracts will be of

practical importance to those who are certain of the exchange rate risk. This contract

will involve buying of the securities at the current price and the sell it according to the

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agreement at the specified time and price (Anon., 2009). This will hedge the

company from an exchange rate risk. The buying of a future contract is also

beneficial as it locks the price of the commodity at the specified future price to hedge

against the exchange rate risk (Saefong, 2012).

DEMAND AND SUPPLY OF LUXURIOUS CARS

The car market is gaining popularity due to super luxurious car models like

Lamborghini, Saleen S5S Raptor, Mach7 Falcon, Mosler MT900, HTT Plethore LC-

750, Ford GT etc. (Vijayenthiran, 2011). The characteristics of these cars can be

known through their names. However, as the global economy breakdown occurred in

2008, this lowered the demand for such luxurious sports cars. The situation further

deteriorated with the outbreak of another global economic breakdown during 2010.

This included the event of European Debt Crisis (Voss, 2011). However, USA

Supercars should not look for selling their cars in the foreign market because the

exchange rate is uncertain and it can be favourable and unfavourable on different

occasions that cannot be considered beneficial for any company like USA

Supercars. More than that, they should focus on generating profit from the domestic

currency because there is no uncertainty in the domestic currency. As USA

Supercars has one customer from USA which has a certain revenue without any risk

or danger of exchange rate uncertainty. Therefore, there should be only one

possibility to let the demand and supply increase in the domestic market but the

sales should be made to the foreign market only when the exchange rate is

favourable. Even if the demand increases worldwide for such luxurious cars, then

there is a possibility of an exchange rate risk which will definitely benefit the

customers in some way as if their currency strengthens against US $ then the

revenue will decrease for USA supercars. However, the revenue can increase under

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one condition if the sale is being made to many different customers worldwide and to

domestic customers also.

EXCHANGE RATE UNCERTAINTY

The Bank of America provides the data for exchange rate so that the decision can be

made regarding the selling of luxury cars to the foreign market. Nevertheless, the

company should not give the only priority to the data provided. However, the Bank

has taken every possible variable to calculate the exchange rate between US and

other countries where the sale is yet to be made. It is also necessary to take

necessary steps for domestic promotion. This would be favourable for the company

because only economic breakdown can prevent the company from generating

profits. Hence, it is therefore necessary for the company to promote their products to

sell them to domestic customers in order to increase their CERTAIN revenue. The

word UNCERTAIN revenue creates a havoc for the future as the future exchange

rate is unpredictable and the prediction cannot be done based on economic activities

and indicators (Du & Zhu, 2001).

DATA ANALYSIS

The table in an appendices show the data of seven customers for USA Supercars.

The selling price is in the local currency of the respective country zones and the

exchange rates provided by the Bank of America are estimated on a 1-year basis i.e.

12 months from now. The data is normally distributed and independent. From the

data, it can be revealed that Japan has a lower revenue due to its mean and

standard deviation provided. This increases the risk for selling to Japanese market.

The chart in an appendices show that the highest average revenue return is from the

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12 quantities of supercars by customers of UK. The total mean for an uncertain

revenue is $2192868 whereas the standard deviation for the company is $44668.32.

Standard Deviation

1995258987.76

(=((57000*0.041)^2*12^2)+((8500000*5+9000000*3)^2*0.00045^2)+

((97000*1+100000*3)^2*0.0342^2)+((4100000*0.00083)^2*2^2))

Square root (1995258987.76)

44668.3220

The second question deals with the possible revenues probability. The first condition

to deal with is the probability of revenue exceeding by $2,200,000. By looking at the

z-score table in appendices, the probability is 0.4364 or 43.64%. The second

condition deals with the probability of revenue exceeding by $2,225,000. By looking

at the Z score table, the probability for this condition is 0.2358. The third question

deals with the first condition of probability of the revenue being less than 2,150,000.

The probability for this condition is 0.1685 or 16.85%. The second condition deals

with the probability of the revenue being less than $2,120,000. The probability for

this condition is 0.0516 or 5.16%. The figure for standard normal distributions are

shown in appendices.

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The fourth question deals with decision-making on accepting an offer from HSBC-an

international bank. HSBC offers to pay a specific sum of $2,150,000 in return for the

revenue calculated from the selling of luxury cars to seven customers worldwide. It

can be said that this sure sum is $44668 less than the calculated revenue. The

decision to accept this offer will cost them 1.95% of the revenue in local currency.

Nevertheless, the sure sum offer is certain and there will be no effect on this sum

even if there is a high exchange rate risk. I personally think that USA supercars

should accept the offer because they sum is certain in the local currency.

The fifth question deals with the risk averse investor. The sales manager is willing to

accept the offer from an international bank but the CEO of the company is not

satisfied with the offer. This means that the sales manager is more risk averse than

the CEO as the sales manager is willing to accept the certain sum from the bank but

the CEO is not satisfied with the offer as it is $42868 less than the uncertain

revenue. This shows that the sales manager is more conservative as he knows that

this amount will be compensated if exchange rate risk occurs due to economic

disruptions.

The bank is possibly taking an interest rate risk other than the exchange rate risk.

Because the Bank is providing the sure sum without any interest. It must be noticed

that the provided money must be from the deposits of other customers in current or

savings account. If the deposit is from the savings account, then there will some

interest expense to be paid for that account by the bank. Either the bank is certain

about the exchange rate risk that will prove favourable for them or they are taking

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risk to earn more money than the sure sum. However, the current scenario shows

that the bank is taking an interest rate risk.

If the offer is to be paid within 3 months rather than 12 months then this will create a

major difference, as the bank will have to make the payment without interest 9

months early that is neither favourable nor beneficial for them. If the decision is to be

made on what is preferred by both the parties separately, then the bank would prefer

to make the payment in 12 month time since the sure sum is to paid without any

interest. However, the USA Supercars will prefer to receive the payment within 3

months because this will prove more favourable to them since through this there will

a good effect on the Asset section of the balance sheet. They will be able to manage

and enhance their cash flow operations. Their Accounts receivable account will

increase which will generate a positive increase in the value of assets of USA

Supercars.

Now if the USA Supercars accepts the offer from HSBC then there is a certain

probability that the bank will make a loss if the revenue goes down by $2,150,000.

Since the exchange rate is uncertain and unpredictable, it cannot be said that the

revenue received at the prevailing exchange rates will be the same when the

customers pay the amount. This will depend on exchange rate at the time of

payment made by the customers. However, the probability of the revenue being less

than $2,150,000 is 0.1685. There is 16.8% chance that the revenue will be less than

$2,150,000.

The bank defines it value at risk at fifth percentile of the revenue i.e. 95% confidence

interval. The expected value at risk for the bank is $50326. There is 5% chance that

the bank will lose more than this amount. However, the above expected value at risk

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is just an estimate. The actual calculation will be an accurate value at risk and will be

somehow around it. Whereas, the bank’s expected profit is $42868 if the prevailing

exchange rates remain the same throughout the 12-month period. If the exchange

rate is not the same as the prevailing ones then the profit can either change into a

loss. This shows that the bank is taking an exchange rate risk. One cannot possibly

predict an exact exchange rate and hence the expected profit is just an assumption

based on prevailing exchange rates.

If the bank does not want to convert all the currencies into US$ then there are

several ways. The bank can spend or save them as a local currency or convert them

into some other needed currency. This will however decrease the risk faced by the

bank. Because as far as less conversion is involved, the risk will be less. This is

because of the exchange rate uncertainty. The risk of exchange rate is high when

the US dollar weakens against other currencies that can generate net loss for the

bank and their sure sum will be a source of their loss.

CONCLUSION

The above analysis shows that the certain revenue other than uncertain revenue is

effective because it can generate a negative outcome for the company. The

company USA supercars has a very good offer to accept from the bank. Both the

parties have 50% chance of attaining a positive return since the word UNCERTAIN

creates uncertainty for accepting the offer. Since the bank provides the exchange

rate data, they must be certain about the deviations in the exchange rates. They

might be certain that there is a high probability of revenue exceeding by $2,150,000.

There can be different views regarding this situation. Nevertheless, if the opposite

happens for the bank, the bank will bear loss from two perspectives. They will bear

loss from interest rate point of view. Since they are providing a sure sum of

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$2,150,000 without any interest being charged to USA supercars. According to me,

the best option would be to prefer the sure sum offer and even prefer the payment to

be made within 3 months to gain a sudden advantage of getting the payment even

less than $44668 is acceptable. They will not have to pay the interest expense for

getting the payment within 3 months. I think that this is the best option for the

company.

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BIBLIOGRAPHY

Anon., 2009. Merk Funds. [Online]

Available at: http://www.merkfunds.com/currency-asset-class/currencies-unplugged/what-is-a-spot-

currency-contract.html

[Accessed 17 November 2013].

Anon., 2010. Agri Xchange. [Online]

Available at: http://agriexchange.apeda.gov.in/Ready%20Reckoner/How_to_Avoid_Exchange.aspx


Du, H. & Zhu, Z., 2001. The effect of exchange-rate risk on exports: Some additional empirical

evidence. Journal of Economic Studies, 28(2), pp. 106-121.

IISD, 2009. IISD. [Online]

Available at: http://www.iisd.org/susprod/principles.htm


Knight, M., 2012. WikiHow. [Online]

Available at: http://www.wikihow.com/Hedge-Currency


Reed, J. T., 2012. US Foreign Exchange. [Online]

Available at: http://www.johntreed.com/are-US-forex-trading-accounts-an-adequate-way-to-hedge-

against-USD-inflation.html


Saefong, M. P., 2012. Market Watch. [Online]

Available at: http://www.marketwatch.com/story/how-to-buy-futures

[Accessed 17 Novemeber 2013].

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Vijayenthiran, V., 2011. Motor Authority. [Online]

Available at: http://www.motorauthority.com/news/1054428_americas-mach7-motorsports-

presents-falcon-supercar


Voss, J., 2011. Enterprising Investor. [Online]

Available at: http://blogs.cfainstitute.org/investor/2011/11/21/european-sovereign-debt-crisis-

overview-analysis-and-timeline-of-major-events/


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APPENDICES

Figure 1 Total Mean of uncertain revenue

Standard Deviation

1995258987.76

Square root (1995258987.76)

44668.3220

(=((57000*0.041)^2*12^2)+((8500000*5+9000000*3)^2*0.00045^2)+

((97000*1+100000*3)^2*0.0342^2)+((4100000*0.00083)^2*2^2))

Figure 2 Calculation for Standard Deviation of total uncertain revenue

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Figure 3 Graph for Mean for different customers

Figure 4 Standard Deviation for USA Supercars customers

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Figure 5 Chart for Standard Deviation USA customers

Figure 6 Illustrative Answer for 2a

Figure 7 Illustrative Answer for 2b

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Figure 8 Illustrative Answer for 3a

Figure 9 Illustrative Answer for 3b = 1-0.95 = 0.0516

ANSWERS TO QUESTIONS1.

Mean of Total Revenue 2192868 $

Variance of Total Revenue 1995258987.76 $^2

Stdev of Total Revenue 44668.322 $

2. Probabilities

P(X > 2,200,000) = The probability that the revenue will exceed $ 2,200,000 is 0.4364

P(X > 2,225,000) = The probability that the revenue will exceed by $ 2,225,000 is

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0.2358

3. Probabilities

P(X < 2,150,000) = The probability that the revenue will be less than $2,150,000 is

0.1658

P(X < 2,120,000) = The probability that the revenue will be less than $2,120,000 is

0.516

4. The sure sum is a good offer because the revenue is certain. However, it costs 1.95% to USA

supercars to select this option

5. The sales manager is more risk averse because he is willing to get an exact amount of

$2,150,000 but the CEO feels that the company should give more than this amount on the

prevailing exchange rates.

6. The bank is taking an interest rate risk since they will be provide the sure sum without an

interest.

7. If the sure sum is to be paid within 3 months, then USA supercars will receive the amount 9

months early. However, the bank will prefer to pay the amount in 12 month time to avoid

paying the amount without any interest 9 months early. While, the company prefers the

opposite. It will opt for the payment to be made within 3 months.

8. Same as answer to part 3(a)

9. Expected value at risk = $50326

The above value shows that there is 5% that the bank will lose more than this amount and the

expected profit is $42868.

10. Buy some spot price contracts. The bank can also buy forward and future contracts in order to

hedge against exchange rate risk.

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