Dozier Industries (A) Case

Value: 100 points, 10% of Final Grade Due: Submit by the end of Day 3

You will complete a write-up for the Dozier Industries (A) Case. The case tests your knowledge of hedging with a forward contract. Your case write-up must be submitted and will be graded.

Read the Dozier Industries (A) Case in your course pack. Additional information is provided below.

Case A: Additional Information

You should treat January 14, 1986, as the date when you are performing your analysis and acting on the analysis (hedging or not hedging).

The prime rate is the rate at which the bank lends to its most creditworthy corporate customers. It is lending from the banks perspective, but borrowing from Dozier's perspective.

Deposits are borrowing on the part of a bank, but lending from the perspective of a customer such as Dozier.

To reduce risk, Dozier will take the 10% initial deposit (pounds) and sell the pounds in the spot market on Jan 14.

Any dollars that Dozier receives on Jan 14 are deposited in the bank for 90 days.

Read the (A) case, and then address the following questions: 1. If Dozier uses the forward contract to hedge, what is Dozier's profit in U.S. dollars? (Hint: Since Dozier's motive is hedging, you first calculate the revenue in dollars that Dozier will receive for the Pound receivable. Then subtract Dozier's Costs given in exhibit 3). 2. If Dozier uses the spot transaction suggested in the case, what is Dozier's profit in U.S. dollars? (Hint: Since Dozier's motive is hedging, you first calculate the revenue in dollars that Dozier will receive for the Pound receivable. Then subtract Dozier's Costs given in exhibit 3. Hint 2: The case gives you instructions on how to construct a spot transaction hedge (also known as a money market hedge). To properly hedge, keep in mind that your pound inflows (the receivable) and outflows (loan repayment) must be equal. This means that the future value of the loan (total loan repayment including interest) must equal the receivable. If the amount borrowed (a present value) is equal to the receivable, then the loan repayment (pound outflow) will be greater than the receivable (pound inflow) and you will not be hedged.) 3. Given the data in exhibit 5, calculate all 12 week (approximately 90 days) percentage changes in the exchange rate. There will be 16 to calculate (e.g. 7-9-85 to 10-1-85, 7-16-85 to 10-08-85,, 10-22-85 to 1-14-86). Take the absolute value of each percentage change. What is the largest percentage change? What is the average percentage change? 4. Assume that the percentage decrease in value of the pound is equal (in absolute value; the direction of the change, positive or negative, may differ) to the largest percentage change in the pound. Calculate Dozier's profit or loss in U.S. dollars from remaining unhedged. 5. Assume that the percentage increase in value of the pound is equal (in absolute value; the direction of the change, positive or negative, may differ) to the largest percentage change in the pound. Calculate Dozier's profit or loss in U.S. dollars from remaining unhedged. 6. Assume that the percentage decrease in value of the pound is equal (in absolute value; the direction of the change, positive or negative, may differ) to the average percentage change in the pound. Calculate Dozier's profit or loss in U.S. dollars from remaining unhedged. 7. Assume that the percentage increase in value of the pound is equal (in absolute value; the direction of the change, positive or negative, may differ) to the average percentage change in the pound. Calculate Dozier's profit or loss in U.S. dollars from remaining unhedged. 8. Would you recommend that Dozier use the forward hedge, spot transaction hedge, or remain unhedged? Explain. (Hint: the comparison between the forward hedge and the spot transaction hedge should be straightforward because the risk is the same. However, if unhedged, the risk is greater. You will need to read the case carefully and use the information given in the case about Dozier along with your answers to questions above to make an argument