CASE STUDY Tamil Nadu Steel is one of the major steel dealers in the world. It other countries, the customers are invoiced in U.S. dollars, except has its headquarters in Chennai and a branch office in London, for customers in Europe, where they are invoiced in euros. United Kingdom. Tamil Nadu Steel purchases steel from steel com- Tamil Nadu Steel purchases the steel required for any month panies in India and supplies it to customers in various parts of the at the beginning of the month and pays for the steel in Indian world, except India since there are many Indian steel companies rupees to the Indian steel mills by the end of the month in which that provide steel for customers in India. the steel was bought. For example, the steel needed to be sold When Tamil Nadu Steel purchases steel from Indian steel in the month of January will be purchased on January 1 and the companies, the price is determined in U.S. dollars, but the money payment will be made to the steel companies in Indian rupees on is to be paid in Indian rupees. When it sells steel to customers in January 31. The customers require that Tamil Nadu Steel quotes the price at The cost of shipping and other costs in relation to selling steel for which the steel will be sold one month in advance. That is, the price various regions are estimated in US dollars: USA:USD 64; Europe: at which Tamil Nadu Steel will sell steel in the month of January USD 52; Asia: USD 40; Others: USD 56 will have to be quoted to the customers on December 1 itself. The Tamil Nadu Steel sells steel with a margin of 14%. This is over customers who have bought the steel will pay the amount due the price paid for the steel and other costs. on the last day of the month in which the sales are made. The Tamil Nadu Steel has made forecasts of its sales to customers customers will pay the amount of purchase in either U.S. dollars or in the various regions for the next year, as shown in Table 1. in euros on January 31. Table 1 Demand for Steel (in MT) USA Total Month January February 68,000 Europe 18,000 18,000 18,000 20,000 22,500 March Asia 35,000 38,000 42,000 45,000 45,000 50,000 66,000 72,000 Others 7,000 4,000 6,000 5,000 3,500 4,500 April 8,000 6,000 6,000 8,000 10,000 12,500 15,000 18,000 18,000 16,000 78,000 81,000 May June 25,000 July 25,000 50,000 55,000 50,000 5,000 6,000 92,000 95,000 99,000 August September October 20,000 20,000 18,000 18,000 48,000 50,000 5,000 5,000 5,000 6,000 93,000 87,000 85,000 November 12,000 10,000 December 18,000 50,000 84,000 Steel prices have been highly volatile during the period between Table 2 Forward Prices of Steel (USD per MT) January 2008 and May 2009. The price of hot-rolled steel coil steadily increased from USD 639 per MT in January 2008 to USD Delivery Month Forward Price 1,099 per MT by June 2008. From June 2008, the price started falling, and it was selling at USD 474 per MT in May 2009. A January 740 similar pattern was also seen for the other steel products such February 780 as hot-rolled steel plate, cold-rolled steel coil, steel wire rod, and medium steel sections. The prices of all these products increased March 850 from January 2008 and reached a maximum in July 2008. From July 2008, the prices started falling, and by May 2009, all these products April 940 were selling at very low prices. This is a big concern for Tamil May 1,200 Nadu Steel, because it has to provide the quotes to its customers one month in advance. In order to hedge its risk, Tamil Nadu Steel June 1,060 approached the steel mills in India to arrange for forward contracts 1,020 in steel. Table 2 shows the forward prices of steel for delivery in each month. August 940 September 850 October 740 November 700 December 640 July Tamil Nadu Steel estimated that it would require USD 50 million to Table 3 Exchange Rates: Spot and Forward Rates finance the working capital as well as for warehouse construction and maintenance. It has entered into a floating-rate loan, whose Month Rupees per Rupees details are as follows: U.S. dollar per euro Amount of principal USD 50 million 49.2852 70.6359 Interest rate January 1 (Spot) 6-month LIBOR + 150 basis points Interest reset period Every six months, on January 1 January 31 (Forward) 49.4639 70.3875 and July 1 Tenor of loan Three years February 28 (Forward) 43.8368 70.2422 LIBOR on January 1 6.25% March 31 (Forward) 50.0354 70.1211 To reduce the interest rate risk, Tamil Nadu Steel enters into a 6x 12 forward rate agreement with the Emerson group, London, the April 30 (Forward) 50.1245 69.8754 terms of which are as follows: May 31 (Forward) 49.6738 69.8245 Notional Principal Amount USD 50 million June 30 (Forward) 49.6542 69.4758 AR 8.1% RR 6-month LIBOR + 150 basis points July 31 (Forward) 49.4958 69.6492 At the end of every month, the Emerson Group will remit the receipt August 31 (Forward) 50.3475 69.8345 from sales after keeping 5% of the sales for the next month as reserve. Since the payment to the steel suppliers will be in Indian rupees and September 30 (Forward) 50.8678 69.9892 the remittance every month will also be in Indian rupees, Tamil October 31 (Forward) 51.2432 70.4579 Nadu Steel has collected the following information on exchange rates between the U.S. dollar and the Indian rupee as well as between November 30 (Forward) 51.5487 70.5682 the euro and the Indian rupee. This is presented in Table 3. December 31 (Forward) 51.3845 70.7459 The analysts have predicted that the 6-month LIBOR for the U.S. dollar will be 6.95% on June 30. Discussion Questions Calculate the amount in Indian rupees that will be left with Tamil Nadu Steel at the end of every month if the costs involved in running the Chennai office is INR 0.15 million. The balance on January 1 is INR 4 million. Assume that Tamil Nadu Steel will hedge steel price risk, exchange rate risk, and interest rate risk through forward contracts. CASE STUDY Tamil Nadu Steel is one of the major steel dealers in the world. It other countries, the customers are invoiced in U.S. dollars, except has its headquarters in Chennai and a branch office in London, for customers in Europe, where they are invoiced in euros. United Kingdom. Tamil Nadu Steel purchases steel from steel com- Tamil Nadu Steel purchases the steel required for any month panies in India and supplies it to customers in various parts of the at the beginning of the month and pays for the steel in Indian world, except India since there are many Indian steel companies rupees to the Indian steel mills by the end of the month in which that provide steel for customers in India. the steel was bought. For example, the steel needed to be sold When Tamil Nadu Steel purchases steel from Indian steel in the month of January will be purchased on January 1 and the companies, the price is determined in U.S. dollars, but the money payment will be made to the steel companies in Indian rupees on is to be paid in Indian rupees. When it sells steel to customers in January 31. The customers require that Tamil Nadu Steel quotes the price at The cost of shipping and other costs in relation to selling steel for which the steel will be sold one month in advance. That is, the price various regions are estimated in US dollars: USA:USD 64; Europe: at which Tamil Nadu Steel will sell steel in the month of January USD 52; Asia: USD 40; Others: USD 56 will have to be quoted to the customers on December 1 itself. The Tamil Nadu Steel sells steel with a margin of 14%. This is over customers who have bought the steel will pay the amount due the price paid for the steel and other costs. on the last day of the month in which the sales are made. The Tamil Nadu Steel has made forecasts of its sales to customers customers will pay the amount of purchase in either U.S. dollars or in the various regions for the next year, as shown in Table 1. in euros on January 31. Table 1 Demand for Steel (in MT) USA Total Month January February 68,000 Europe 18,000 18,000 18,000 20,000 22,500 March Asia 35,000 38,000 42,000 45,000 45,000 50,000 66,000 72,000 Others 7,000 4,000 6,000 5,000 3,500 4,500 April 8,000 6,000 6,000 8,000 10,000 12,500 15,000 18,000 18,000 16,000 78,000 81,000 May June 25,000 July 25,000 50,000 55,000 50,000 5,000 6,000 92,000 95,000 99,000 August September October 20,000 20,000 18,000 18,000 48,000 50,000 5,000 5,000 5,000 6,000 93,000 87,000 85,000 November 12,000 10,000 December 18,000 50,000 84,000 Steel prices have been highly volatile during the period between Table 2 Forward Prices of Steel (USD per MT) January 2008 and May 2009. The price of hot-rolled steel coil steadily increased from USD 639 per MT in January 2008 to USD Delivery Month Forward Price 1,099 per MT by June 2008. From June 2008, the price started falling, and it was selling at USD 474 per MT in May 2009. A January 740 similar pattern was also seen for the other steel products such February 780 as hot-rolled steel plate, cold-rolled steel coil, steel wire rod, and medium steel sections. The prices of all these products increased March 850 from January 2008 and reached a maximum in July 2008. From July 2008, the prices started falling, and by May 2009, all these products April 940 were selling at very low prices. This is a big concern for Tamil May 1,200 Nadu Steel, because it has to provide the quotes to its customers one month in advance. In order to hedge its risk, Tamil Nadu Steel June 1,060 approached the steel mills in India to arrange for forward contracts 1,020 in steel. Table 2 shows the forward prices of steel for delivery in each month. August 940 September 850 October 740 November 700 December 640 July Tamil Nadu Steel estimated that it would require USD 50 million to Table 3 Exchange Rates: Spot and Forward Rates finance the working capital as well as for warehouse construction and maintenance. It has entered into a floating-rate loan, whose Month Rupees per Rupees details are as follows: U.S. dollar per euro Amount of principal USD 50 million 49.2852 70.6359 Interest rate January 1 (Spot) 6-month LIBOR + 150 basis points Interest reset period Every six months, on January 1 January 31 (Forward) 49.4639 70.3875 and July 1 Tenor of loan Three years February 28 (Forward) 43.8368 70.2422 LIBOR on January 1 6.25% March 31 (Forward) 50.0354 70.1211 To reduce the interest rate risk, Tamil Nadu Steel enters into a 6x 12 forward rate agreement with the Emerson group, London, the April 30 (Forward) 50.1245 69.8754 terms of which are as follows: May 31 (Forward) 49.6738 69.8245 Notional Principal Amount USD 50 million June 30 (Forward) 49.6542 69.4758 AR 8.1% RR 6-month LIBOR + 150 basis points July 31 (Forward) 49.4958 69.6492 At the end of every month, the Emerson Group will remit the receipt August 31 (Forward) 50.3475 69.8345 from sales after keeping 5% of the sales for the next month as reserve. Since the payment to the steel suppliers will be in Indian rupees and September 30 (Forward) 50.8678 69.9892 the remittance every month will also be in Indian rupees, Tamil October 31 (Forward) 51.2432 70.4579 Nadu Steel has collected the following information on exchange rates between the U.S. dollar and the Indian rupee as well as between November 30 (Forward) 51.5487 70.5682 the euro and the Indian rupee. This is presented in Table 3. December 31 (Forward) 51.3845 70.7459 The analysts have predicted that the 6-month LIBOR for the U.S. dollar will be 6.95% on June 30. Discussion Questions Calculate the amount in Indian rupees that will be left with Tamil Nadu Steel at the end of every month if the costs involved in running the Chennai office is INR 0.15 million. The balance on January 1 is INR 4 million. Assume that Tamil Nadu Steel will hedge steel price risk, exchange rate risk, and interest rate risk through forward contracts