Case: The Thor Corporation 1 THE THOR CORPORATION Richard Mawby, Treasurer of the Thor Corporation, scheduled a meeting with his three junior associates to discuss the recent turbulence in the foreign exchange markets. In particular, he was worried about the exposure of the company's receivables and payables denominated in foreign currencies. The company, a manufacturer of specialized speakers, had always purchased their raw materials and sold their products locally. This all changed recently when they received their first international order from Britain. As a test case, their new client ordered a total of 2,000 pieces of their high-end PC_2100 model to be delivered in two equal installments. The first batch of 1,000 pieces will be delivered on July 1, 2016 followed by a second batch six months later on January 1, 2017. After several negotiations, the company agreed on a price of 200 each. All shipping charges will be borne by the British client. The terms of payments include a letter of credit that guarantees payment 90 days after shipment of the goods. This year also saw the company import for the first time, hinges for mounting the speaker components. This component was previously purchased from a supplier in Iowa. Their new purchasing manager Brian Gomez, who had previously worked for a large electronic company, initiated this arrangement. The main consideration was price. He convinced Richard Mawby that the same hinges could be purchased at half the price with the same quality from a Brazil manufacturer. After extensive negotiations, an initial contract was signed to import a total of 10,000 hinges at a price of BR16 (Brazilian Reals) each that included the cost of shipping. The terms of payment included a letter of credit that guaranteed payments 90 days after shipment of the goods. The shipment will also be delivered in two batches, 5000 pieces on July 1, 2016 and the remaining 5,000 pieces on January 1, 2017. Although Richard Mawby was aware of currency risk and hedging strategies, he was not concerned about them till today. However, this morning he read in the Financial Times that there was a strong probability that the dollar would appreciate in the near term. This got him thinking about his new overseas ventures, prompting him to schedule the meeting. He also called his bank manager, Stuart Elmer of State Bank, to obtain his opinion on this matter and to receive some preliminary quotes for foreign exchange hedging instruments. At the meeting, he was surprised to find out that his junior associates were quite knowledgeable about foreign exchange volatility and its potential impact on their new overseas orders (he made a note to himself to ask them which business schools they attended). Although their current exposure may not affect their total cash flows significantly, they agreed to examine alternative hedging strategies in anticipation of growth in their foreign sales and purchases. Case: The Thor Corporation 2 Richard Mawby distributed copies of the quotes faxed to him by his banker (See Exhibit 1) and informed them that the rates were effective as of today, November 16, 2015, and were valid till February 22, 2016. This should give them enough time to thoroughly study the issue. They next discussed the following hedging alternatives. 1. Forward Hedging: It would allow the company to purchase and sell foreign currencies forward and lock in to a given rate. The bank manger said that transaction costs would run approximately percent for both the six-month and 1-year contracts. 2. Money Market Hedge: The banker told Richard that they could arrange money to be borrowed and invested in both countries. No collateral would be required for borrowing money overseas. The fees for spot currency transactions would be 1/2%. The fee for investing overseas would be 1/8%.The fees for borrowing both overseas and domestically would be approximately 3/4%. These rates are applicable for all countries. 3. Options Hedge: The banker also agreed to sell both call and put options on both currencies. The rates vary and are shown in Exhibit 1. There will be no additional fees for the purchase of options, as they would be covered in the premiums. The discussion then turned to the forecasts of exchange rates. Everyone agreed that it was difficult to predict the rates that would prevail six to 12 months from today. Brian Gomez, one of the associates, agreed to look up several web sites of federal agencies such as the Federal Reserve Bank and Small Business Administration, and financial institutions such as Merrill Lynch and Goldman Sachs etc. and prepare a report that summarizes the market's expectation of the future spot rates for both currencies. (See Exhibit 2). At the end of the discussion, Richard Mawby asked the team to prepare a report on whether it is necessary to hedge their current exposures. If they recommend hedging their exposures, they should provide all necessary details. He requested the report be prepared as quickly as possible so that he could inform the CEO of this latest development and seek permission in case a hedge is warranted. Case: The Thor Corporation 3 EXHIBIT 1 QUOTES PROVIDED BY STATE BANK Date: November 16, 2015 Validity: These rates are guaranteed up to February 22, 2016 Please contact Stuart Elmer for any clarifications. British Pounds Brazilian Reals Spot Rates $1.56/ $0.30/BR Six Month Forward Rates $1.54/ $0.29/BR One-year Forward Rates $1.55/ $0.31/BR Six-Month Borrowing rates 8.00% p.a. 12% p.a. One year Borrowing rates 8.50% p.a. 12.5% p.a. Six-Month Investing rates 4.25% p.a. 8% p.a. One-year Investing rates 4.75% p.a. 8.5% p.a. Premiums for calls and puts Type Maturity Exercise Price Premium Exercise Price Premium Call 6-month $1.56/ 3.0% $0.30/BR 1.75% Call 6-month $1.58/ 2.2% $0.32/BR 0.50% Call 6-month $1.54/ 4.3% $0.28/BR 4.00% Call 12-month $1.56/ 3.5% $0.30/BR 2.25% Call 12-month $1.58/ 2.7% $0.32/BR 1.50% Call 12-month $1.54/ 4.8% $0.28/BR 4.75% Put 6-month $1.56/ 2.9% $0.30/BR 1.75% Put 6-month $1.58/ 4.3% $0.32/BR 4.00% Put 6-month $1.54/ 2.2% $0.28/BR 1.25% Put 12-month $1.56/ 3.5% $0.30/BR 2.25% Put 12-month $1.58/ 4.8% $0.32/BR 4.75% Put 12-month $1.54/ 2.7% $0.28/BR 1.75% Note: Premiums are estimated on dollar notional values. Transaction costs for borrowing locally and internationally are paid at the beginning of the contract. Transaction costs for investing locally and internationally are paid at delivery or at the end of the contract. Transaction costs for spot and forward contracts are paid at delivery or at the end of the contract. Case: The Thor Corporation 4 EXHIBIT 2 Report by Brian Gomez After extensively researching several web sites that provided forecasts on the future state of the economy, I have summarized what I believe are the market's expectations of the future foreign exchange rates. There are some wide variations in the forecasts, so I have taken the average of the rates which I thought were most credible. The selected rates coincide with the shipment dates for the export of speakers to Britain and the import of hinges from Brazil: First Shipment Second Shipment Shipment of speakers July 1, 2016 Jan 1, 2017 Import of hinges July 1, 2016 Jan 1, 2017 Expected Spot Rates (quarterly) July 1, 2016 Oct 1, 2016 Jan 1,2017 April 1, 2017 $/ 1.55/ 1.545/ 1.54/ 1.535/ $/BR $0.32/BR $0.33/BR $0.34/BR $0.35/BR The margins of error for both estimates are quite high. For the July 1, 2016 rates, the estimates ranged from $1.45/ to $1.65/ and $0.15/BR to $0.35/BR. Consequently, I recommend that we consider +/- $0.15 cents to compensate for the uncertainty, perhaps even +/- $0.20 for additional safety. The company uses a cost of capital of 12% for evaluating projects of similar risk. Case: The Thor Corporation 5 INCOME STATEMENT AND BALANCE SHEET FOR THOR CORPORATION December 31, 2014 In US dollars INCOME STATEMENT Revenues 12,739,500 Cost of Good Sold 8,434,222 Overheads 1,200,234 Selling and Administrative Expenses 700,699 Miscellaneous Costs 452,344 Interest Expenses 672,333 Extraordinary Expenses 256,333 Earning before Taxes 1,023,335 Taxes (adjusted for loss carryover) (1) 225133.7 Net Income 798,201 NOTES: (1) Thor managed to save $112,566 in taxes by applying loss carry forwards for 2014. (2) No more loss carry forwards are available. BALANCE SHEET Cash 122,789 Accounts Payable 864552 Marketable Securities (4%)1 242,673 Notes Payable (8%)2 1,400,893 Accounts Receivables 1,600,364 Accrued Taxes and Wages 700527 Inventory 2,335,621 Long Term Debt (12%)3 1455624 Net Plant and Equipment 3,897,777 Retained Earnings 2,577,628 8,199,224 Common Stock 1,200,000 8,199,224 Notes: 1. Marketable securities earn approximately 4% with average maturity being 3 months. Longer-term maturities earn % more for every additional three months. 2. Notes Payables is generated through a $2,000,000 revolving line of credit. Current rate is 8%. 3. Long Term Debt has been obtained through a single creditor. Maturity is 10 years. Interest of 12% is payable annually. Assignment Please prepare 4-5 page report for Richard Mawby with your recommendations on how the firm should hedge the above receivables and payables. Please provide an Excel sheet to show the expected payoffs. The report should explain your assumptions and the derived numbers as shown in your the Exhibits. The report should end with a justification of your recommendations.

Case: The Thor Corporation THE THOR CORPORATION Richard Mawby, Treasurer of the Thor Corporation, scheduled a meeting with his three junior associates to discuss the recent turbulence in the foreign exchange markets. In particular, he was worried about the exposure of the company's receivables and payables denominated in foreign currencies. The company, a manufacturer of specialized speakers, had always purchased their raw materials and sold their products locally. This all changed recently when they received their first international order from Britain. As a test case, their new client ordered a total of 2,000 pieces of their high-end PC_2100 model to be delivered in two equal installments. The first batch of 1,000 pieces will be delivered on July 1, 2016 followed by a second batch six months later on January 1, 2017. After several negotiations, the company agreed on a price of 200 each. All shipping charges will be borne by the British client. The terms of payments include a letter of credit that guarantees payment 90 days after shipment of the goods. This year also saw the company import for the first time, hinges for mounting the speaker components. This component was previously purchased from a supplier in Iowa. Their new purchasing manager Brian Gomez, who had previously worked for a large electronic company, initiated this arrangement. The main consideration was price. He convinced Richard Mawby that the same hinges could be purchased at half the price with the same quality from a Brazil manufacturer. After extensive negotiations, an initial contract was signed to import a total of 10,000 hinges at a price of BR16 (Brazilian Reals) each that included the cost of shipping. The terms of payment included a letter of credit that guaranteed payments 90 days after shipment of the goods. The shipment will also be delivered in two batches, 5000 pieces on July 1, 2016 and the remaining 5,000 pieces on January 1, 2017. Although Richard Mawby was aware of currency risk and hedging strategies, he was not concerned about them till today. However, this morning he read in the Financial Times that there was a strong probability that the dollar would appreciate in the near term. This got him thinking about his new overseas ventures, prompting him to schedule the meeting. He also called his bank manager, Stuart Elmer of State Bank, to obtain his opinion on this matter and to receive some preliminary quotes for foreign exchange hedging instruments. At the meeting, he was surprised to find out that his junior associates were quite knowledgeable about foreign exchange volatility and its potential impact on their new overseas orders (he made a note to himself to ask them which business schools they attended). Although their current exposure may not affect their total cash flows significantly, they agreed to examine alternative hedging strategies in anticipation of growth in their foreign sales and purchases. 1 Case: The Thor Corporation Richard Mawby distributed copies of the quotes faxed to him by his banker (See Exhibit 1) and informed them that the rates were effective as of today, November 16, 2015, and were valid till February 22, 2016. This should give them enough time to thoroughly study the issue. They next discussed the following hedging alternatives. 1. Forward Hedging: It would allow the company to purchase and sell foreign currencies forward and lock in to a given rate. The bank manger said that transaction costs would run approximately percent for both the six-month and 1-year contracts. 2. Money Market Hedge: The banker told Richard that they could arrange money to be borrowed and invested in both countries. No collateral would be required for borrowing money overseas. The fees for spot currency transactions would be 1/2%. The fee for investing overseas would be 1/8%.The fees for borrowing both overseas and domestically would be approximately 3/4%. These rates are applicable for all countries. 3. Options Hedge: The banker also agreed to sell both call and put options on both currencies. The rates vary and are shown in Exhibit 1. There will be no additional fees for the purchase of options, as they would be covered in the premiums. The discussion then turned to the forecasts of exchange rates. Everyone agreed that it was difficult to predict the rates that would prevail six to 12 months from today. Brian Gomez, one of the associates, agreed to look up several web sites of federal agencies such as the Federal Reserve Bank and Small Business Administration, and financial institutions such as Merrill Lynch and Goldman Sachs etc. and prepare a report that summarizes the market's expectation of the future spot rates for both currencies. (See Exhibit 2). At the end of the discussion, Richard Mawby asked the team to prepare a report on whether it is necessary to hedge their current exposures. If they recommend hedging their exposures, they should provide all necessary details. He requested the report be prepared as quickly as possible so that he could inform the CEO of this latest development and seek permission in case a hedge is warranted. 2 Case: The Thor Corporation EXHIBIT 1 QUOTES PROVIDED BY STATE BANK Date: November 16, 2015 Validity: These rates are guaranteed up to February 22, 2016 Please contact Stuart Elmer for any clarifications. Spot Rates Six Month Forward Rates One-year Forward Rates Six-Month Borrowing rates One year Borrowing rates Six-Month Investing rates One-year Investing rates British Pounds Brazilian Reals $1.56/ $1.54/ $1.55/ 8.00% p.a. 8.50% p.a. 4.25% p.a. 4.75% p.a. $0.30/BR $0.29/BR $0.31/BR 12% p.a. 12.5% p.a. 8% p.a. 8.5% p.a. Premiums for calls and puts Type Maturity Exercise Price Premium Exercise Price Premium Call Call Call Call Call Call 6-month 6-month 6-month 12-month 12-month 12-month $1.56/ $1.58/ $1.54/ $1.56/ $1.58/ $1.54/ 3.0% 2.2% 4.3% 3.5% 2.7% 4.8% $0.30/BR $0.32/BR $0.28/BR $0.30/BR $0.32/BR $0.28/BR 1.75% 0.50% 4.00% 2.25% 1.50% 4.75% Put Put Put Put Put Put 6-month 6-month 6-month 12-month 12-month 12-month $1.56/ $1.58/ $1.54/ $1.56/ $1.58/ $1.54/ 2.9% 4.3% 2.2% 3.5% 4.8% 2.7% $0.30/BR $0.32/BR $0.28/BR $0.30/BR $0.32/BR $0.28/BR 1.75% 4.00% 1.25% 2.25% 4.75% 1.75% Note: Premiums are estimated on dollar notional values. Transaction costs for borrowing locally and internationally are paid at the beginning of the contract. Transaction costs for investing locally and internationally are paid at delivery or at the end of the contract. Transaction costs for spot and forward contracts are paid at delivery or at the end of the contract. 3 Case: The Thor Corporation EXHIBIT 2 Report by Brian Gomez After extensively researching several web sites that provided forecasts on the future state of the economy, I have summarized what I believe are the market's expectations of the future foreign exchange rates. There are some wide variations in the forecasts, so I have taken the average of the rates which I thought were most credible. The selected rates coincide with the shipment dates for the export of speakers to Britain and the import of hinges from Brazil: Shipment of speakers Import of hinges First Shipment Second Shipment July 1, 2016 July 1, 2016 Jan 1, 2017 Jan 1, 2017 Expected Spot Rates (quarterly) July 1, 2016 Oct 1, 2016 Jan 1,2017 April 1, 2017 $/ 1.55/ 1.545/ 1.54/ 1.535/ $/BR $0.32/BR $0.33/BR $0.34/BR $0.35/BR The margins of error for both estimates are quite high. For the July 1, 2016 rates, the estimates ranged from $1.45/ to $1.65/ and $0.15/BR to $0.35/BR. Consequently, I recommend that we consider +/- $0.15 cents to compensate for the uncertainty, perhaps even +/- $0.20 for additional safety. The company uses a cost of capital of 12% for evaluating projects of similar risk. 4 Case: The Thor Corporation INCOME STATEMENT AND BALANCE SHEET FOR THOR CORPORATION December 31, 2014 In US dollars INCOME STATEMENT Revenues Cost of Good Sold Overheads Selling and Administrative Expenses Miscellaneous Costs Interest Expenses Extraordinary Expenses Earning before Taxes Taxes (adjusted for loss carryover) (1) Net Income 12,739,500 8,434,222 1,200,234 700,699 452,344 672,333 256,333 1,023,335 225133.7 798,201 NOTES: (1) Thor managed to save $112,566 in taxes by applying loss carry forwards for 2014. (2) No more loss carry forwards are available. BALANCE SHEET Cash Marketable Securities (4%)1 Accounts Receivables Inventory Net Plant and Equipment 122,789 242,673 1,600,364 2,335,621 3,897,777 8,199,224 Accounts Payable Notes Payable (8%)2 Accrued Taxes and Wages Long Term Debt (12%)3 Retained Earnings Common Stock 864552 1,400,893 700527 1455624 2,577,628 1,200,000 8,199,224 Notes: 1. Marketable securities earn approximately 4% with average maturity being 3 months. Longer-term maturities earn % more for every additional three months. 2. Notes Payables is generated through a $2,000,000 revolving line of credit. Current rate is 8%. 3. Long Term Debt has been obtained through a single creditor. Maturity is 10 years. Interest of 12% is payable annually. Assignment Please prepare 4-5 page report for Richard Mawby with your recommendations on how the firm should hedge the above receivables and payables. Please provide an Excel sheet to show the expected payoffs. The report should explain your assumptions and the derived numbers as shown in your the Exhibits. The report should end with a justification of your recommendations. Copyright: Anoop Rai, 2015 5