Case 2: Hedging Transaction Exposure Sarah Scott and George Stoeckert

The Case  December 2012: DW orders part from Japan, incurs a payable of 200,000, JPY  Parts are received in April  Payment due in May

Part I

Associated Risk: Best/Worst Case Scenario JPYExchange RateMultiplierOutcome Range Best Case Scenario 200,000, $ 1,932, $ 960, Worst Case Scenario 200,000, $ 2,893,475.94

99% Confidence Interval: $ 62, JPY Transaction Exposure Today +/- Confidence IntervalOutcomeRange Upper Bound 200,000, $ 2,308, $ 2,371, $ 125, Lower Bound 200,000, $ 2,308, $ 2,245, Associated Risk: Simulated Distribution

Normal Distribution 99% Confidence Interval: JPYExchange RateMultiplierOutcomeRange Upper Bound 200,000, $ 2,290, $ 35, Lower Bound 200,000, $ 2,326, Associated Risk: Normal Distribution

Value at Risk Calculation VaR: Exchange RateJPYασΔtΔtVaR 4mo ,000, $ 367, mo ,000, $ 459, Δt in terms of 4 months

PHLX Options Estimated Spot Rate CallsOptionPremium Total Option Price Total Premium Price Total Combined Price April Spot Rate April Close Out April Close Out + Premium ProbabilityExercise Option? PHLX Option June $ 1,600, $ 916, $ 2,516, $ 2,462, $ 3,379, %YES PHLX Option June $ 1,600, $ 916, $ 2,516, $ 2,505, $ 3,422, %YES PHLX Option June $ 1,600, $ 916, $ 2,516, $ 2,548, $ 3,465, %YES Estimated Spot Rate CallsOptionPremium Total Option Price Total Premium Price Total Combined Price April Spot Rate April Close Out Close Out + PremiumProbabilityExercise Option? PHLX Option June $ 1,800, $ 725, $ 2,525, $ 2,462, $ 3,187, %YES PHLX Option June $ 1,800, $ 725, $ 2,525, $ 2,505, $ 3,230, %YES PHLX Option June $ 1,800, $ 725, $ 2,525, $ 2,548, $ 3,273, %YES Estimated Spot Rate CallsOptionPremium Total Option Price Total Premium Price Total Combined Price April Spot Rate April Close Out Close Out + PremiumProbabilityExercise Option? PHLX Option June $ 2,000, $ 590, $ 2,590, $ 2,462, $ 3,053, %YES PHLX Option June $ 2,000, $ 590, $ 2,590, $ 2,505, $ 3,096, %YES PHLX Option June $ 2,000, $ 590, $ 2,590, $ 2,548, $ 3,139, %YES

Frequency Distribution: 4-Month Changes

OTC Options: Estimated Spot Rate CallsOptionPremium Total Option Price Total Premium Price Interest EarnedTotal Combined Price March Spot Rate March Close Out March Close Out + Premium Probability Exercise Option? OTC Option March.009 $ $ $ 1,800, $ 816, $ 77, $ 2,538, $ 2,461, $ 3,278, %YES OTC Option March.009 $ $ $ 1,800, $ 816, $ 77, $ 2,538, $ 2,501, $ 3,317, %YES OTC Option March.009 $ $ $ 1,800, $ 816, $ 77, $ 2,538, $ 2,541, $ 3,357, %YES Estimated Spot Rate CallsOptionPremium Total Option Price Total Premium Price Interest EarnedTotal Combined Price March Spot Rate March Close Out March Close Out + Premium Probability Exercise Option? OTC Option March.01 $ $ $ 2,000, $ 639, $ 77, $ 2,562, $ 2,461, $ 3,101, %YES OTC Option March.01 $ $ $ 2,000, $ 639, $ 77, $ 2,562, $ 2,501, $ 3,141, %YES OTC Option March.01 $ $ $ 2,000, $ 639, $ 77, $ 2,562, $ 2,541, $ 3,180, %YES

Frequency Distribution: 3-Month Changes

Forward Alternative Requirement (Due March 15th) 200,000, Current Exchange Rate JPY/USD (12/15/12) Interest Rate US 6mo Interest Rate Japan 6mo Forward Rate Dec 6- May Month Forward Contract Cost $ 2,733,247.10

Cost Comparison: Hedging Alternatives

Part II Hedging Transaction Exposure

What would be the effective total cost (in USD) of the Japanese parts if you had advised…  Using three months forward?  Long 3 Month Forward (Dec & March)  (Dec-Mar) 200,000,000 JPY * (3 Month FR) = $2,498,  Rolled into new 3 month Forward and calculated the new 3 Month Forward Rate in March 2015:  (Mar-June) 200,000,000 JPY * = $2,122,  Cash Outflows from transactions = $374, $106,  Short 1 Month Forward (May-June)  Shorted 1 Month Forward to Close Position with opposite transactions  (May-June) 200,000,000 JPY * (1 Month Forward) = $2,092,800  Cash inflow from transactions = $76,  Cost of Forward Premiums = $404,  Value of JPY in May = $2,008,  Total Cost (excluding other undocumented fees) = $2,412,461.79

 Using six months forward?  (Dec-June) Long 6 Month JPY Forward  200,000,000 JPY * (6 Month FR) = $2,512,  Value of JPY in June = $2,015,  Cash Outflow of $496,  (May-June) Short 1 Month JPY Forward  200,000,000 JPY * (1 Month FR) = $2,092,800  Cash Inflow of $76,  Cost of Forward Premiums = $419,400  Value of JPY in May = $2,008,  Total Cost (excluding other undocumented fees) = $2,427,400 What would be the effective total cost (in USD) of the Japanese parts if you had advised…

 Using June Futures?  Long (Dec-June) 200,000,000 JPY * (June Future Rate) = $2,514,  Cash Outflow  Close position with Short (May-June) 2000,000,000 JPY * = $2,000,  Cash Inflow  Total Cost of Future Premiums = $513,600  Value of JPY in May = $2,008,  Total Cost of Future = $2,521,600

What would be the effective total cost (in USD) of the Japanese parts if you had advised…  Using the OTC JPY Option?  Call Both Options  Invest JPY on March 17 th = 200,000,000 * = 200,091,880 JPY  Interest Earned = 91,880 JPY  Purchase JPY for Payment = 200,000,000 * = $2,000,  Convert Interest = 91,880 JPY * = $  OTC.009 Total Cost = $2,616,200 - $ = $2,615,  OTC.010 Total Cost = $2,639,520 - $ = $2,638,597.53

What would be the effective total cost (in USD) of the Japanese parts if you had advised…  If the PHLX June Options had been…  Total Cost of JPY with (June.008 Call) = $2,009,  Total Cost of JPY with (June.009 Call) = $2,011,  Total Cost of Option (June.010 Call) = $2,590,840.00

What would be the effective total cost (in USD) of the Japanese parts if you had advised…  Left Position Open?  Value of JPY in USD (Dec 2012) = $2,308,  Additional Interest Income (Low Interest Rate Assumed) = $4,  $2,308, * (.23%/6*12*(150/360)) = $4, Cash Inflow  Value of JPY in May = 200,000,000 (JPY) * (St) = $2,008,000 USD  Total Cost of JPY Less Additional Interest Income = $2,003,560.17

Final Comparison Open Position Is Most Risky but Least Expensive  Left Position Open  PHLX  3 Month Forwards  6 Month Forwards  Futures  OTC  $2,003,  $2,009,  $2,412,  $2,427,  $2,521,  $2,615,277.53