Europe company has a receivable of $144.927millon

Today spot rate: US$1.4706 = 1 Euro

Consider and evaluate the following methods and determine if it would be beneficial to hedge or not hedge the methods.

First method

Foreign Currency Loan

This product would create a US$ obligation 180 days in the future, which would be discharged by the final

dollar contract payment to VSC in November. VSC could borrow today the present value of the dollars to

be received in November. The dollars would be immediately exchanged for euros at the current spot rate,

and either be used to fund working capital needs, pay down debt, or invested in a euro financial instrument.

Thus, VSC could borrow US$ from the bank at todays meeting and convert the loan proceeds to euros to

help finance the completion of the contract. The dollars received on November 17 from completing the

contract would discharge the dollar loan, interest, and principal. Any exchange rate gains or losses on the

receivable due to a change in the value of the US$ per euro exchange rate would be offset by matching losses

or gains on the US$ per euro value of the loan.

In his role as chief foreign exchange advisor, the banker believed that a 180-day loan in U.S. dollars could

be made today at a rate of 2.0 percent above the U.S. dollar prime rate of 6.00 percent per annum plus an

arrangement fee of 0.125 percent. The comparable prime euro interest rate was 5.50 percent, with VSC

receiving a spread of 1.85 percent in the euro market for short-term investments.

Second Method

Presale of Foreign Contract

Peter also knew that it was possible to presell the balance due on the foreign contract, or receivable, at a

discount as an alternative method of hedging exchange rate risk and raising funds to help VSC finance the

completion of the project. This alternative was different from a foreign currency loan in that it would not

add to VSCs already large outstanding debt. The discount, or interest rate, for the presale was fixed for the

180-day period at US$ LIBOR (London Inter-Bank Offered Rate), currently at 4.15 percent per annum

plus a credit risk spread for VSC of 1.8 percent. The arrangement fee for setting up this transaction was

a flat upfront fee of 0.5 percent. The current euro six-month LIBOR was 4.35 percent plus a comparable

credit spread.

Regarding the longer-term six-year service agreement, VSCs bankers recommended exploring the following

options: check if VSC had any offsetting U.S. dollar or parallel foreign currency payments (e.g., Canadian

$) to match the U.S. dollar receivable or determine if it made sense to use back-to-back or parallel loan ar- rangements, or cross-currency U.S dollar-euro swap to offset the expected U.S. dollar receivable.