Download - TCAS case
TCAS case
Questions to consider:
1. FX forecast.
2. Financial needs of TCAS
3. Real mark-up on the bid? Was the use of spot rate the correct approach?
4. Alternatives for the hedge? Which one?
Issues with the FX rate
Ways of forecasting FX rate, given the data in the case:
1. BOP data2. IRP3. PPP4. Government policies
Use of the BOP data
The BOP data is provided in exhibit 3. Important factors to be examined:
1. GDP growth2. Inflation3. Government deficit4. Gross savings5. Investments6. Current account7. Capital account8. ST/LT interest rates
Relationship between GDP and FX rate
The greater the "real" growth rate, the greater the potential for income growth, higher interest rates (real), and higher income and investments.
All these should lead to an appreciation in the base currency
Relationship between Remaining factors and FX rate
Inflation and FX rate---NegativeGovernment deficit---NegativeSavings---Positive to neutralInvestments---PositiveST/LT interest rate (real)---positive
Details on "settlement" and FX rate
"Settlement" is the difference between the Current and Capital account. The relationship between the two is almost perfectly negative.
The FX forecasting from BOP examines the Settlement issue. There are three possibilities for this account:
1. Zero (no pressure)--S=D2. Less than zero (negative pressure) S>D3. Greater than zero (positive pressure)S<D
In the latter two cases the outcome is far from certain.
For example, if "less than zero", use of FX reserves and or intervention using trade policies.
Possible scenarios from combination of BOP elements
1. Settlement less than zero, country inflation is higher than other's; domestic real rates lower than the partner's; currency should depreciate
2. Settlement is in deficit; inflation lower; real rates lower; FX rate should depreciate
3. Settlement positive; Inflation lower; Real rates higher; Strong appreciation
4. Settlement positive; inflation higher; Real rates higher' Appreciation.
The bid
Mark-up = 5%
Uses Spot rate to get the bid price
10% collection in May, rest in August
No factor for changes in FX rate was included
Included in the bid was development expense of $300K
Quantitative Analysis
Forward contract
C$2.6M/1.3653 = $1.911M
Foreign currency loanC$ loan amount: C$2.6M/(1+(.1250/4)) = C$2.53M
Less arrangement fee: C$ 0.03125M
Net Loan C$2.53-0.003125 = 2.527M
Convert into $:
C$2.527/C$1.3594 = $1.859M
Opportunity cost of $ debt: $1.859*(1+(.11/4)) = $1.910M
Write a call on C$ at strike of $0.72 (C$ equivalent of 1.39)
Premium received: 0.0356*C$2.6M = $92916
Best case analysis
C$2.6M*(0.72+0.0356) = $1.972M
Break-even rate with the forward rate
(1/1.3653) - 0.0356 = $0.6969
Buy a Put on C$- Strike price of $0.72
Premium paid = 0.0225*2.6M = $58725
Worst case:
C$2.6M*(0.72 - 0.0025) = $1.82M
Break-even with forward rate = (1/1.3653) +0.0025 = 0.755
Conclusions thus far
If expect the spot rate to > 0.755, buy a put
If between 0.6969 and 0.7566, write a call
If less than 0.697, sell forward
Futures contract
C$2.6M * 0.735 - 1300 = $1.917M
Pre-sale of contract
Loan amount: C$2.6M/(1+(0.092/4)) - C$2.55M*0.005 = C$2.538M
Translate into $: C$2.538M/1.3594*(1+(.11/4)) = $1.918M
Tunnel forward
Best case: 2.6M*0.7533 = $1.966M
Worst case:2.6M*0.7133 = $1.861M
Summary of Advantages/Disadvantages
AD Disadvantage
Forward Certaninty Locked
Easy execution Credit facilityBudgeting;Planning
MM hedge As above LockedDocuments
Futures Forward not allowed Not tailoredAdm costBasis risk
Options Flexibility
Unlimited gains Premium
Range-TunnelForward Low cost option Limited
upside
Year Current Capital Settlement Expected results Expected1990 -20.7 23.2 2.5 Appreciate1991 -23.6 22.1 -1.5 Depreciate1992 -21.4 16.8 -4.6 Depreciate1993 -22.3 22.9 0.6 Neutral1994 -16.3 12.3 -4 Depreciate1995 0
Parity Conditions
89 90 91 92 93 94FX rate 1.18 1.167 1.15 1.21 1.29 1.366InflationCanada 4.8 5.6 1.5 1.8 0.2U.S. 5.4 4.2 3 3 2.6Difference -0.6 1.4 -1.5 -1.2 -2.4PPP 1.1773 1.18 1.13 1.19 1.26
Interest rateCanada 0.13 0.09 0.67 0.05 0.54U.S. 0.075 0.05 0.03 0.03 0.042Diff 0.055 0.04 0.64 0.02 0.498IFE 1.2446 1.21 1.18 1.23 1.305Real ratesCanada 0.082 0.03 0.05 0.03 0.052U.S. 0.021 0.01 0 0 0.016Diff 0.061 0.02 0.05 0.03 0.036IFE 1.117 1.14 1.1 1.17 1.246
Ratio analysis
Current 0.67Quick 0.62Cl/TL 0.7ST debt/LT 1.31D/E 1.06Average collection 85
Bid analysis
Bid Components Nature
Design Soft costMaterials Hard costLabor Hard costShipping Hard costDirect Overhead Hard costIndirect Overhead Soft cost