Truckee Tec is a privately held battery manufacturer located just outside of Reno, Nevada. The company is one of the leading manufacturers of lithium-ion batteries, specifically for the automobile market. Truckee has been in intense contract negotiations with a Japanese automaker for months. It was late December 2016, and both sides wanted to conclude a deal before the new year.

The Japanese automaker wanted a two-year supply agreement for 18,000 lithium-ion 12V battery packs per year. Battery prices had been dropping dramatically for years, but Truckee’s current sales price of \($1,100\) per battery for the 12V model (1342OR) had held firm for months. The buyer was pushing for a lower unit price, but Truckee wanted a longer contract with higher volumes in return. After months of negotiations, the buyer agreed to increase the contract to three years, and increase annual purchases to 20,000 units. But in return, the buyer wanted a price of \($990\) per unit, and it wanted to pay in Japanese yen. Truckee had countered with the following proposal. Assuming 20,000 units per year at an average price of \($995\) per unit, and a current spot exchange rate of ¥115.00 = \($1.00,\) the contract purchase amount per year would be:

Annual contract amount = 20,000 units

\($995\) per unit * ¥115 per dollar = ¥,288,500,000 

The buyer accepted the counterproposal in 24 hours and a sale agreement signed and posted. The deal was done. Almost immediately the corporate treasury group at Truckee was upset about the contract.

They argued that the Japanese yen had begun to plummet in value against the dollar in the past two months, so accepting payment in Japanese yen was too risky. Also, the quote had been based on a spot rate value of ¥115 = \($1.00,\) but the rate had already moved to ¥117 = \($1.00\) over the past two weeks.
Truckee’s corporate treasury wanted to move immediately to hedge the long-term exposure. (Internally, the group had discussed that it was technically an anticipated transaction exposure, not a pure operating exposure, since it was a single transaction—
but contractual. It would continue over a three-year period, but none of it was as yet on the books.) After consulting with their bankers, they wanted to use a cross-currency swap to manage the Japanese yen risk, a swap in which Truckee would pay yen and receive dollars. Their banker offered a swap where Truckee would receive U.S.
dollar LIBOR in return for paying Japanese yen at 4.500%. The swap agreement would be for three years and all payments made quarterly—to match the expected yen cash inflow from the Japanese customer.

a. Given the final contract value, what would the Japanese buyer believe they are paying per pack?

b. What is the amount of the currency exposure for Truckee Tec?

c. If the swap agreement is for a three-year loan at 4.500%, quarterly, what is the principal amount of the loan obligation (notional principal)?

d. The sales team had clearly not updated their exchange rate assumption prior to making the final contractual offer. As a result, assuming the swap was executed the same day as the closing spot rate quote, what was the actual exchange rate locked-in for the three-year period?

e. In retrospect, what do you think Truckee should have done to manage the currency risk more effectively?