CASE CURRENCY RISK MANAGEMENT

A Colombian company named Tiburon S.A. has recently decided to expand its international
trade relationship by exporting to the United Kingdom. Swims Ltd., a British retailer, has
committed itself to the annual purchase of 200,000 pairs of Speedos, Tiburon’ primary product,
for a price of £80 per pair. The agreement is to last for 2 years, at which time it may be renewed
by Tiburon and Swims.

In addition to this new international trade relationship, Tiburon continues to export to Thailand.
Its primary customer there, a retailer called SportX, is committed to the purchase of 180,000
pairs of Speedos annually for another 2 years at a fixed price of 4,594 Thai baht per pair. When
the agreement terminates, it may be renewed by Tiburon and SportX.

Tiburon also incurs costs of goods sold denominated in Thai baht. It imports materials sufficient
to manufacture 72,000 pairs of Speedos annually from Thailand. These imports are denominated
in baht, and the price depends on current market prices for the rubber and plastic components
imported.

Under the two export arrangements, Tiburon sells quarterly amounts of 50,000 and 45,000 pairs
of Speedos to Swims and SportX, respectively. Payment for these sales is made on the first of
January, April, July, and October. The annual amounts are spread over quarters in order to avoid
excessive inventories for the British and Thai retailers. Similarly, in order to avoid excessive
inventories, Tiburon usually imports materials sufficient to manufacture 18,000 pairs of Speedos
quarterly from Thailand. Although payment terms call for payment within 60 days of delivery,
Tiburon generally pays for its Thai imports upon delivery on the first day of each quarter in order
to maintain its trade relationships with the Thai suppliers. Tiburon feels that early payment is
beneficial, as other customers of the Thai supplier pay for their purchases only when it is
required.

Since Tiburon is relatively new to international trade, Harald Verstappen, Tiburon’ chief
financial officer (CFO), is concerned with the potential impact of exchange rate fluctuations on
Tiburon’ financial performance. Holt is vaguely familiar with various techniques available to
hedge transaction exposure, but he is not certain whether one technique is superior to the others.
Holt would like to know more about the forward, money market, option hedges, range forward,
and participating forward, and has asked you, a financial analyst at Tiburon, to help him identify
the hedging technique most appropriate for Tiburon.

Unfortunately, no options are available for Thailand, but British call and put options are
available for £31,250 per option. Holt has gathered and provided you with the following
information for Thailand and the United Kingdom:
 THAILAND UNITED KINGDOM

Current spot rate COP 92 COP 6000

90-days forward rate COP 86 COP 5960

Put option premium n/a COP 80 per unit

Put option exercise price n/a COP 5880

Call option premium n/a COP 60 per unit

Call option exercise price n/a COP 5920

90-days borrowing rate 4% (nonannualized) 2% (nonannualized)

90-days lending rate 3.5% (nonannualized) 1.8% (nonannualized)

90-days range forward COP 82 / COP 90 COP 5910 / COP 6010

90-days participating forward 85.5 (GR) 5940 (GR)

85 (PR) 5930 (PR)
50% (P) 50% (P)

In addition to this information, Holt has informed you that the 90-day borrowing and lending
rates in Colombia are 2.3 and 2.1 percent, respectively, on a nonannualized basis. He has also
identified the following probability distributions for the exchange rates of the British pound and
the Thai baht in 90 days:

SPOT RATE FOR THE THAI SPOT RATE FOR THE

PROBABILITY BAHT IN 90 DAYS BRITISH POUND IN 90
DAYS

5% COP 80.0 COP 5800

20% COP 85.2 COP 5880

30% COP 86.8 COP 5920

25% COP 88.0 COP 5960

15% COP 92.0 COP 6000

5% COP 94.0 COP 6080

Tiburon’ next sales to and purchases from Thailand will occur 1 quarter from now. If Tiburon
decides to hedge, Holt will want to hedge the entire amount subject to exchange rate fluctuations,
even if it requires overhedging (i.e., hedging more than the needed amount). Currently, Holt
expects the imported components from Thailand to cost approximately 3,000 baht per pair of
Speedos. Holt has asked you to answer the following questions for him:

1. Which type of currency risk is Tiburon exposed to? Explain your answer (transaction/
translation/economic exposure)

2. Does Tiburon have a long or a short position in regards to the Thai baht? Explain your
answer.

3. Using a spreadsheet, compare the hedging alternatives for the Thai baht with a scenario
under which Tiburon remains unhedged. Do you think Tiburon should hedge or remain
unhedged? If Tiburon should hedge, which hedge is most appropriate?

4. What is the most important difference between a forward market hedge and an options
market hedge?

5. Suppose that during this 90-day period, the British pound strengthened (= appreciates)
against the Colombian peso. Assuming neither Tiburon nor Swims Ltd hedge against
currency risk, what would be the currency gain or loss for each party as a result of this
transaction?

Tiburon Swims
A. No gain or loss Gain
B. Gain No gain or loss
C. No gain or loss Loss
D. Loss No gain or loss

6. What the advantage of a range forward contract compared to a standard forward contract?

7. Using a spreadsheet, compare the hedging alternatives for the British pound receivables
with a scenario under which Tiburon remains unhedged. Do you think Tiburon should
hedge or remain unhedged? Which hedge is the most appropriate for Tiburon?

8. In general, do you think it is easier for Tiburon to hedge its inflows or its outflows
denominated in foreign currencies? Why?

9. Given Tiburon’ exporting agreements, are there any long-term hedging techniques Tiburon
could benefit from? For this question only, assume that Tiburon incurs all of its costs in
Colombian peso.