looking for the solution for this hedging on Porsche case.

Recalibrated to PUT USD Euro Sales Currency Spot USD Sales Currency $/ Currency /$ Simulated EUR USD Conversion Risk Currency $/ Put Option Price (1Yr) Euro Notional Simulated Option MV Change in Option MV Change in Option MV USD Conversion Risk Net Hedge Effect BASE CASE 2,000 1.45 $ 2,900 1.35 1.45 0.7407 0.6897 2,148 2,000 148 0 1.25 0.8000 1.25 1.35 0.02200179 6,000 6,000 132 - 117 $ - 117 148 $ 31 1.45 0.04146 6,000 249 0 0 0 1.55 0.6452 1.55 1.65 0.6061 1.65 THIS MODEL IS CALIBRATED FOR VALUATION IN EUROS USE THESE /$ SPOT RATES TO SOLVE THE PORSCHE CASE Currency $/ Currency /$ 1.25 0.8000 1.35 0.7407 EUROPEAN FX OPTION PRICING MODEL - VALUATIONS in Spot Rate(e.g. EUR) = 0.6897 Spot Rate(FX USD)= 1.0000 Euro Interest Rate = 4.500% Exercise Price = Days to Expiration = 0.6897 (1/1.45) 730 d1 = (z-score) -0.0640 d2 = (z-score) -0.2054 Call Option Premium = 0.0296 To simulate price of USD Put expressed in EUR terms replace the /$ spot price in the orange highlighted cell. 1.45 0.6897 1.55 0.6452 1.65 0.6061 VALUATIONS in EUROs Forward Rate(e.g. EUR) = 0.6766 Forward Rate (FX USD) = 1.0000 Foreign Interest Rate = 5.500% Option Volatility = 10.000% Years to Expiration (T) = 2.0000 N(d1) = (conditional probability) 0.4745 N(d2) = (cumulative probability) 0.4186 Put Option Premium = 0.0415 possible spot strike price value/unit exposure 1.0000 0.6897 -0.3103 1.0500 0.6897 1.1000 0.6897 1.1500 0.6897 1.2000 0.6897 1.2500 0.6897 1.3000 0.6897 1.3500 0.6897 1.4000 0.6897 1.4500 0.6897 1.5000 0.6897 1.5500 0.6897 1.6000 0.6897 1.6500 0.6897 option value premium net value For the exclusive use of J. Sexton, 2017. case W04C40 August 6, 2015 Hedging at Porsche When Porsche made headlines, it was usually for the engineering of the latest edition of one of its famous sports carsnot for complex financial engineering. But the results presented at the company's annual press conference on November 28, 2007, stunned the business world. While Porsche made a respectable profit of around 1bni from manufacturing and selling cars, this number was dwarfed by the huge profits Porsche made from transactions in financial derivatives. Porsche had undertaken large trades in the foreign exchange options market that paid off handsomely as the U.S. dollar weakened. Moreover, Porsche had bought a huge number of options on shares of Volkswagen, Europe's biggest automaker. These trades together added roughly 4 billion of profit to Porsche's bottom line.1 Analysts were divided in their reaction when Holger Hrter, Porsche's CFO, presented these stunning results. Some went as far as to describe Hrter as a \"financial genius.\" Others questioned the wisdom of an industrial company engaging in derivatives trades of this scale. Some analysts remarked wryly that Porsche had become a \"hedge fund.\"2 Did Porsche simply earn the fruits of prudent and clever risk management? Or did these results indicate that Porsche's executives engaged in reckless financial policies that exposed the company to outsized risks? Background With headquarters in Stuttgart, Germany, Porsche was a manufacturer of performance sports cars. Its product line in 2007 included the 911, Boxster, and Cayman sports cars, and the Cayenne sports utility vehicle. The four-door Panamera was planned to be launched in 2009. The production of the 911 and Cayenne vehicles took place at the company's German plants in Stuttgart and Leipzig, while much of the assembly of the Boxster and Cayman was outsourced to the Finnish company Valmet.3 The company's sales were heavily dependent on the U.S. and German markets. Each one of these two markets accounted for about a third of total sales in the fiscal year 2006/07.4 i The exchange rate at the end of November 2007 was 1.47 $ per . Published by WDI Publishing, a division of the William Davidson Institute (WDI) at the University of Michigan. 2014 Stefan Nagel. This case was written by Stefan Nagel (Michael Stark Professor of Finance at the Ross School of Business) at the University of Michigan to be the basis for class discussion rather than to illustrate either the effective or ineffective handling of a situation. Secondary research was performed to accurately portray information about the featured organization. Company representatives were not involved in the creation of this case. This document is authorized for use only by James Sexton in 2017. For the exclusive use of J. Sexton, 2017. Hedging at Porsche W04C40 In the early 1990s Porsche had been on the brink of bankruptcy. At the time, sales were heavily dependent on a single product: the 911 sports car. As recession hit the United States and Germany, sales of expensive sports cars slumped. Combined with the effects of a weak U.S. dollar, this had a devastating effect on Porsche. Sales fell dramatically from more than 50,000 a year to 14,000 units in 1993.5 In 1993, then 40-year-old Wendelin Wiedeking was appointed as CEO to lead Porsche out of this crisis. Under his leadership the company brought in former Toyota engineers from Japan to adopt lean manufacturing techniques, and it focused on the development of the Boxster, a new entry-level model priced considerably below the 911.6 In a relatively short time, Porsche completed a successful turnaround. Wiedeking was still CEO in 2007. By that time Porsche had achieved the highest profit margins in the industry, earning itself the label \"most profitable car company in the world.\"7 Porsche was essentially a privately held company. The company had two classes of shares: ordinary shares with voting rights and preferred nonvoting shares. All of Porsche's 8.75 million ordinary shares were held by the Pich and Porsche families. The 8.75 million (nonvoting) preferred shares were publicly traded and the majority held by institutional investors.8 Risk Management Policy Porsche's risk management policy was strongly influenced by its experience of nearly going bankrupt in the early 1990s. Its policy was grounded in several lessons Porsche's executives learned from this period of trouble. First, Porsche aimed to have little leverage on its balance sheet and a cushion of ample liquidity. The firm had little long-term debt. Its financial liabilities, which consisted mostly of bank loans and bonds, accounted for only a small fraction of total assets. It also maintained a balance of cash and highly liquid cash-equivalent assets of more than 2bn (see Appendix A). Instead of relying on credit lines provided by banks, the company preferred to keep significant cash balances. This cautious policy also had its roots in Porsche's troubles in the early 1990s. When the crisis hit back then, the company struggled as banks became unwilling to extend credit. As Porsche CFO Holger Hrter put it, \"We learned the hard way that banks are there for you when you don't need them, and when you do need them, they're nowhere to be seen.\"9 Second, Porsche aimed to hedge, to a large extent, its foreign exchange exposure. During the troubles of the early 1990s Porsche was not well hedged against a falling U.S. dollar, which compounded the problems the company faced at the time. Its German competitors BMW and Mercedes responded to this challenge by establishing and expanding production facilities in the United States. By increasing their dollar-cost base, they were trying to match dollar revenues with dollar costs. Porsche chose not to go down this route of establishing such a \"natural hedge.\" Instead, it relied on foreign exchange derivatives to hedge its exposure to foreign exchange risk.10 Foreign Exchange Hedging Porsche's foreign exchange hedging program made use of foreign exchange options. Options were used to lock in a desired floor to the exchange rate. In particular, Porsche often used at-the-money optionsii to lock in an exchange rate close to the current spot rate.11 ii An option is called an at-the-money option if the price of the underlying asset equals the strike price. 2 This document is authorized for use only by James Sexton in 2017. For the exclusive use of J. Sexton, 2017. Hedging at Porsche W04C40 For example, on November 30, 2007, the US$- exchange rate stood at a spot rate of 1.47 $ per (see Exhibit 1). If Porsche bought one-year put options on the U.S. dollar, at a strike of 1.45 $ per , it obtained the right, but not the obligation, to sell U.S. dollars one year from now at a predetermined exchange rate of 1.45 $ per . In this way, the company locked in a minimum amount of euros it would obtain per U.S. dollar when it converted U.S. dollar revenue from sales in the United States into euros. Exhibit 1 Dollar/Euro Exchange Rate ($ Per ) 1.60 7/31/2007: 1.43$/ 7/31/2007: 1.37$/ 1.40 1.20 1.00 0.80 1/4/99 1/4/00 1/4/01 1/4/02 1/4/03 1/4/04 1/4/05 1/4/06 1/4/07 Note: The average $/ rate during Porsche's fiscal year 2006/07 (ending in July 31, 2007) was 1.31 $/. Source: DataStream. Porsche designed its hedging program so that its forecast sales three years out would be fully hedged (against adverse movements in the exchange rate). This involved buying and rolling over a portfolio of put options with various maturities of up to three years. On July 31, 2007, Porsche held options with a notional amount of 12 billion and a market value of about 0.5 billion (see Exhibit 2).12 Assuming a simple put-option hedge and that the entire position is a U.S. dollar hedge, a notional amount of 12 bn would mean that if Porsche had exercised these put options on July 31, 2007, it would have been able to sell about 12 billion worth of dollars at a pre-determined exchange rate given by the strike of the put options. 12 billion is roughly three times Porsche's annual sales outside of Europe (see Exhibit 3, assuming some growth over the following three years) consistent with Porsche's stated goal of hedging exposure three years out. Porsche believed that it should hedge its foreign exchange exposure largely irrespective of the views about future exchange rate developments that management might have. As Henrik Hnche, Porsche's treasurer, explained: \"We want to avoid the behavioral finance trap, where we act in a certain way because 3 This document is authorized for use only by James Sexton in 2017. Receivables from financial services 1,781,514 1,817,304 1,683,639 1,722,630 For the exclusive use of J. Sexton, 2017. Financial liabilities 6,549,261 Hedging at Porsche 6,450,708 4,809,992 4,743,998 W04C40 The market value of receivables from financial services is determined using the current market interest rates as of the balance sheet date instead of the internal interest rate. we think the current rate of $1.19 to the euro will be higher or lower one month from now. We are convinced 13 that it's not possible to value beatofthe The market the market.\" financial derivatives is disclosed in the balance sheet under other receivables and assets or other liabilities. The residual terms of the currency hedges for US dollar hedges is six years, otherwise no more than four years. Exhibit 2 Notional amounts and market value of derivative financial instruments held by ( thousands) The nominal volume and marketPorsche value of derivative financial instruments are as follows: July 31, 2007 July 31, 2006 Nominal Total market Assets Currency hedge Nominal Total market volume value volume value T T T T 389,003 12,198,361 466,268 8,276,098 Interest hedge 1,091,319 34,998 1,292,744 34,692 Stock options 10,553,364 5,055,224 2,628,055 870,437 23,843,044 5,556,490 12,196,897 1,294,132 1,357,879 13,866 1,441,224 9,572 902,830 27,118 886,812 34,818 Equity and Currency hedge liabilities Interest hedge Stock options 13,473,485 2,445,118 2,441,025 980,716 15,734,194 2,486,102 4,769,061 1,025,106 Source: Porsche, Annual Report 2006/2007. . Exhibit 3 Sales and profit by region ( millions) Germany North America Europe without Germany Rest of the world Sales 2,554 2,218 1,750 847 Profit before financial income and income tax 4,427 142 120 40 Source: Porsche, Annual Report 2006/2007. . This approach was different from that taken by some of Porsche's competitors. For example, after having reaped considerable gains from U.S. dollar hedges as the euro rose against the dollar in the years before 2004, BMW decided to largely abandon its hedge. In January 2004, The New York Times reported about an interview with the head of BMW's risk management, according to which BMW believed that at the current exchange rate of $1.25 the euro was overvalued. The company's computer models suggested that the currency's correct long-term value was around $1.10. Based on this estimate, BMW opted not to hedge heavily.14 The Volkswagen Stake On September 26, 2005, Porsche stunned financial markets when it announced plans to acquire a 20% stake in Volkswagen (VW), Europe's biggest carmaker. While Porsche was a small, highly profitable niche producer, VW was a mass producer struggling to improve its profitability. In addition to the VW brand, VW 4 This document is authorized for use only by James Sexton in 2017. Hedging at Porsche For the exclusive use of J. Sexton, 2017. W04C40 also owned the Audi and Skoda brands, among others.15 The two companies could hardly be more different. Volkswagen sold more than 5 million vehicles per year, with sales approaching 100 billion, while Porsche sold about 90,000 vehicles per year, yielding sales of about 7 billion.16 Porsche's managers, however, believed that they had a good rationale for this unexpected move. They explained that their main objective was to prevent hedge funds from taking over and breaking up VW. Porsche argued that its bid for a VW stake was of critical importance because of Porsche's dependence on VW as its main supplier and as a partner in several joint projects. VW provided about 30% of the components used in Porsche cars. Porsche's Cayenne, VW's Tuareg, and VW subsidiary Audi's Q7 sports utility vehicles shared a common platform. Porsche was also cooperating with VW in the development of the platform for the Panamera, a four-door sports car to be introduced in 2009. The two companies were additionally cooperating on the development of hybrid and fuel-cell models. As a small niche manufacturer, Porsche had difficulty achieving sufficient economies of scale. It said that it needed VW as a reliable partner. A takeover or breakup of VW by some third party would threaten this relationship.17 Critics maintained that this looked like a return to the old days of German \"corporatism,\" where companies and banks had cross-holdings in each other, protecting one another from hostile takeovers and shielding themselves from capital market pressures for improving profitability. Moreover, some critics saw conflicts of interest in the fact that Ferdinand Pich, who served as CEO of VW from 1993 to 2002 and as the head of VW's supervisory board, was also a member of Porsche's supervisory board and owner of a large fraction of Porsche's voting shares.18 VW was a potential target for takeover and breakup, as it had been struggling for many years to achieve and maintain a satisfactory level of profitability. Many analysts argued that the company suffered from large inefficiencies. In particular, analysts criticized the apparent cross-subsidization from its successful and profitable Audi subsidiary to less profitable parts of the company and concluded that VW's breakup value was considerably higher than its value as a combined company.19 For a long time, however, VW had been shielded by an arcane German law (the Volkswagen Act of 1960) that limited the voting rights of any shareholder in VW to a maximum of 20% and gave the federal and regional government seats on the supervisory board of the company. In 2005, at the time when Porsche first announced its intention to buy a large stake in VW, the European Court was expected to mandate that Germany repeal this law in the near future. The European Commission argued that the law conflicted with European Union rules on free movement of capital within the single European market. And in October 2007 the European Court did indeed rule that the Volkswagen law illegally shielded VW from takeovers and it required the German federal government to amend or repeal this law.20 Porsche had hoped for this outcome. In October 2006, it announced its intention to acquire a further 3.9% of VW, raising its stake from then 21.2% to 25.1%. It also announced that it had already bought a sufficient number of call options on VW ordinary shares, so that it faced no price risk in this planned increase in its stake in VW.21 On March 26, 2007, Porsche announced that it had exercised options for the acquisition of a further 3.6% of the ordinary shares of VW, which increased its stake to 30.9%. 22 This increase of its stake above 30% triggered, by law, a requirement to make a mandatory offer for the remaining VW shares. Porsche, however, offered only the minimum price required by the law, 100.92 per ordinary share, which was about 14% below the prevailing market price at the time, so hardly any shareholder took Porsche's offer. At the time Porsche held 27.3% of VW's ordinary shares and had options to buy another 3.7%.23 The offer lapsed in May, and Porsche was now free to increase its stake to 50 percent, if it wished to do so.24 5 This document is authorized for use only by James Sexton in 2017. For the exclusive use of J. Sexton, 2017. Hedging at Porsche W04C40 Porsche had made extensive use of call options on VW ordinary shares to build its stake in VW. Porsche executives argued that this helped them to hedge against the risk that their attempt to buy VW shares would cause VW's stock price to rise. The exact nature of Porsche's option positions remained undisclosed. Some analysts believed that Porsche was holding options to another 60 million of VW shares in November 200725 (compared with 290.3 million ordinary VW shares outstanding).26 Is Porsche a Hedge Fund? Porsche's foreign exchange hedges and the acquisition of the VW stake had a dramatic impact on Porsche's bottom line in the fiscal year 2006/07. On sales of about 7.4 billion, Porsche reported pretax profits of 5.9 billion, up from 2.1 billion in the previous year (see Appendix B). Profits from its VW stock option trades accounted for 3.6 billion of these profits. A further 1.2 billion came from Porsche's share in VW's profits, and thus \"only\" about 1.1 billion from its core business, although that still represented an impressive profit margin by car industry standards. In other words, Porsche made three times as much profit from trades in financial derivatives than from its business of manufacturing and selling cars.27 Moreover, the profit from its core business was also boosted by foreign exchange hedges that Porsche had in place. These hedges contributed 250 million to Porsche's bottom line in 2006/07, as the dollar weakened against the euro.28 Porsche's astonishing results drew praise, but also criticism from analysts and commentators. Some journalists likened Porsche's CFO, Hrter, to a \"financial genius,\" or characterized him as \"more of an options trader than a CFO,\" while others warned that Porsche had just been lucky, and that things might have turned out differently at another time. Some even suggested that Porsche was more like a hedge fund than a car company. A company spokesman replied by pointing out that \"hedge funds don't make cars the last time I checked.\"29 Conclusion Porsche had earned a reputation for a cautious risk management. However, the company's enormous profits from transactions in financial derivatives led many to question whether this was still an accurate description. Should a company such as Porsche engage in derivatives transactions on this scale? Was its approach to building the Volkswagen stake consistent with sound risk management principles or an example of reckless speculation with shareholders' capital? (For additional insight, see Appendices C-G.) 6 This document is authorized for use only by James Sexton in 2017. For the exclusive use of J. Sexton, 2017. Hedging at Porsche 123 Consolidated Balance Sheet of the Porsche Group Appendices as of July 31, 2007 Appendix A Consolidated Balance Sheet of Porsche Group ( thousands) Notes July 31, 2007 July 31, 2006 T Assets T Intangible assets (15) 263,526 250,295 Property, plant and equipment (16) 1,378,435 1,178,352 Investments in associates (17) 7,059,333 3,263,733 Other financial assets (17) 67,584 27,755 Leased assets (18) 990,979 960,650 Trade receivables (20) 20,772 1,990 Receivables from financial services (21) 1,321,635 1,248,750 Other receivables and assets (22) 285,662 172,659 Receivables of taxes on income (23) 63,598 0 Securities (24) 1,014,573 713,072 Deferred tax assets (10) Non-current assets 75,114 152,930 * 12,541,211 7,970,186 * Inventories (19) 625,209 594,080 Trade receivables (20) 245,136 202,981 Receivables from financial services (21) 459,879 Other receivables and assets (22) 5,604,442 Receivables of taxes on income (23) 27,262 Securities (24) 1,419,185 Cash and cash equivalents (25) Current assets 434,889 1,399,988 * 1,306 * 2,048,521 2,410,066 1,988,550 10,791,179 6,670,315 23,332,390 14,640,501 * Equity and liabilities Subscribed capital (26) 45,500 45,500 Capital reserves (26) 121,969 121,969 Revenue reserves (26) 8,507,292 Translation differences (26) - 3,712 Capital allocable to shareholders 8,671,049 4,362,342 * - 1,821 4,527,990 * Hybrid capital (26) 809,977 Minority interests (26) 0 0* 9,481,026 5,337,967 * Equity 809,977 Pension provisions (27) 719,476 Other provisions (28) 624,234 628,512 Deferred tax liabilities (10) 612,826 181,764 Financial liabilities (29) 3,539,237 3,529,650 Trade payables (30) 7,480 3,875 Other liabilities (31) 67,007 51,219 5,570,260 5,053,763 Non-current provisions and liabilities 658,743 Tax provisions (28) 896,643 238,026 Other provisions (28) 1,161,098 1,012,522 Financial liabilities (29) 3,010,024 1,280,342 * Trade payables (30) 505,183 478,942 Other liabilities (31) 2,708,156 1,238,939 8,281,104 4,248,771 * Current provisions and liabilities 23,332,390 14,640,501 * * adjusted Source: Porsche, Annual Report 2006/2007. 7 This document is authorized for use only by James Sexton in 2017. W04C40 122 For the exclusive use of J. Sexton, 2017. Hedging at Porsche Consolidated Income Statement of the Porsche Group for the Period from August 1, 2006 of July 31, 2007 W04C40 Appendix B Consolidated Income Statement of Porsche Group ( thousands) Notes 2006/ 07 2005/ 06 T T (1) 7,367,876 7,122,667 (2) 162,217 172,967 7,530,093 7,295,634 7,264,416 1,045,127 Continuing operations Sales Changes in inventories and other own work capitalized Total operating performance Other operating income (3) Cost of materials (4) - 3,659,520 - 3,273,507 Personnel expenses (5) Amortization and depreciation Other operating expenses - 1,264,325 - 1,037,475 (15), (16), (18) - 531,712 - 488,758 (6) - 4,600,099 - 1,709,318 4,738,853 1,831,703 Profit before financial income Share of profit of associates (7) 1,223,164 203,357 Financial expenses (8) - 272,232 - 198,916 * Financial income (9) 167,215 192,053 * Financial result 1,118,147 196,494 Profit from ordinary activities of continuing operations 5,857,000 2,028,197 Profit from ordinary activities of discontinued operations Profit from ordinary activities 0 81,803 5,857,000 2,110,000 - 713,578 Income taxes from continuing operations (10) - 1,615,000 Income taxes from discontinued operations (10) 0 - 3,422 Income taxes (10) - 1,615,000 - 717,000 4,242,000 1,314,619 0 78,381 4,242,000 1,393,000 - 3,445 Net profit from continuing operations Net profit from discontinued operations (11) Net profit thereof profit allocable to minority shareholders (12) - 10,519 thereof profit allocable to hybrid capital investors (13) 55,556 28,451 thereof profit allocable to shareholders of Porsche AG (13) 4,196,963 1,367,994 Earnings per ordinary share from continiung operations (diluted and basic) (13) 239.80 73.66 Earnings per ordinary share from discontinued operations (diluted and basic) (13) 0.00 4.44 Earnings per preference share from continiung operations (diluted and basic) (13) 239.86 73.72 Earnings per preference share from discontinued operations (diluted and basic) (13) 0.00 4.50 * adjusted Source: Porsche, Annual Report 2006/2007. 8 This document is authorized for use only by James Sexton in 2017. The breakdown of sales by geographical segment and business division can be seen under segment reporting. For the exclusive use of J. Sexton, 2017. Hedging at Porsche W04C40 usinginthe function ofand expense cost of sales without personnel expenses would (2) When Changes inventories own method, work capitalized T 3,859,129 (previous year: T 3,734,615). The of cost of purchased services contains Owncome worktocapitalized is principally a result of the capitalization vehicles and Appendix interest expenses of TC90,958 (previous year: T 76,291). development costs. from financial services transactions Breakdown of Operating Income and Operating Expenses ( Thousands) Personnel expenses (3) (5) Other operating income Other operating income breaks down as follows: 2006/07 2005/06 2006/07 T 2005/06 T Wages and salaries Social security, Income from stock pension options and otherfrom benefit Income the costs reversal of imparments and provisions Exchange rate gains Employees (annual average) * Sundry operating income T T 1,105,349 878,052 6,926,751 158,976 72,988 767,169 159,423 47,538 1,264,325 7,090 1,037,475 9,373 257,587 221,047 4,013 1,045,127 4,178 7,264,416 Wage earners Salaried employees 7,031 Trainees internsmainly results from hedges transactions with cash compensation. 400 Income from stockand options 11,444 Sundry operating income includes income from securities of T 8,855 (previous year: T 0) which previous year employees under the phased retirement scheme was* accounted forincluding at fair value through profit or loss. 6,736 380 11,294 Other operating expenses (4)(6) Cost of materials Other operating expenses consist of: 2006/07 2005/06 2006/07 2005/06 T T T T Cost of materials and supplies andStock of purchased options merchandise 3,128,438 3,333,474 2,819,864 506,139 Advertising Cost of purchased services Selling and general administrative expenses 157,642 3,273,507 159,079 3,659,520 252,994 531,082 249,089 453,643 Dues, charges, fees, legal and advisory costs 88,903 Exchange rate losses 73,736 66,413 Repairs and maintenance 65,255 68,425 Rent and leases Sundry operating expenses 34,789 31,136 30,408 596,959 594,976 4,600,099 1,709,318 Expenses from stock options mainly results from hedges transactions with cash compensation. Sundry operating expenses includes expenses from securities of T 37 (previous year: T 0) which were accounted for at fair value through profit or loss. Source: Porsche, Annual Report 2006/2007. 9 This document is authorized for use only by James Sexton in 2017. not satisfied, so-called recourse factoring, the receivables remain on the balance sheet. For the exclusive use of J. Sexton, 2017. Factoring in the course of asset-backed security transactions which do not satisfy the derecognition Hedging at Porsche criteria resulted in receivables from financial services at a carrying amount of T 1,160 (previous year: W04C40 T 1,079) as of the balance sheet date. The opportunities and risks associated with recourse factoring are essentially comparable to those inherent in receivables that have not been sold. The liabilities associated with the receivables that have been transferred and not derecognized amount to T 1,020 Appendix D (previous year: T 990). Breakdown of Noncurrent and Current Other Receivables and Assets ( Thousands) (22) Non-current and current other receivables and assets July 31, 2007 July 31, 2006 * Derivative financial instruments T T 5,556,490 1,294,132 Other receivables 310,475 259,064 Prepaid expenses 23,139 19,451 5,890,104 1,572,647 thereof non-current thereof current 285,662 172,659 5,604,442 1,399,988 * the current other receivables decreased by T 1,306 in comparison to the previous year due to the transfer of the receivables of taxes on income. The item derivative financial instruments mainly includes forward exchange contracts, currency options, stock options with cash compensation and compounders. A fractional amount of T 268,600 is due in more than one year (previous year: T 157,542). Other assets mainly contain other taxes and advance payments; of these an amount of T 14,892 (previous year: T 12,853) is due in more than one year. Prepaid expenses of T 23,139 (previous year: T 19,451) are principally attributable to the cut-off of other rent and marketing expenses as well as maintenance for hardware and software. Prepaid expenses include accruals and deferrals of T 2,170 due in more than one year (previous year: T 2,264). The fair values of other receivables and financial assets correspond essentially to the carrying amounts. There were no significant valuation allowances for the other receivables and assets disclosed. The financial assets held for trading have a carrying amount of T 5,091,886 (previous year: T 910,111). Source: Porsche, Annual Report 2006/2007. 10 This document is authorized for use only by James Sexton in 2017. For the exclusive use of 169 J. Sexton, 2017. Hedging at Porsche W04C40 Appendix E Maturity of Derivative Financial Instruments Held by Porsche, July 31, 2007 ( Thousands) Nominal volume of derivative financial instruments: Nominal Due within Due within Due within volume one year one to more than five years five years T T T T 12,198,361 2,584,401 8,899,674 714,286 174,595 89,980 84,615 - 12,023,766 2,494,421 8,815,059 714,286 350,000 July 31, 2007 Assets Currency hedge thereof purchase of foreign currencies thereof sale of foreign currencies Equity and Interest hedge 1,091,319 54,313 687,006 Stock options 10,553,364 10,553,364 - - 23,843,044 13,192,078 9,586,680 1,064,286 - Currency hedge liabilities 1,357,879 1,287,065 70,814 thereof purchase of foreign currencies 718,647 718,647 - - thereof sale of foreign currencies 639,232 568,418 70,814 - 310,060 Interest hedge 902,830 - 592,770 Stock options 13,473,485 13,473,485 - - 15,734,194 14,760,550 663,584 310,060 An amount of T 87,590 was reclassified in the fiscal year from the reserve for cash flow hedges to the income statement (previous year: T 155,266). The gain on the disposal of available-for-sale securities totaled T 15,233 (previous year: T 10,955), while the loss on the disposal came to T 0 (previous year: T 2,477). Source: Porsche, Annual Report 2006/2007. (33) Contingent liabilities Appendix F July 31, 2007 July 31, 2006 Zero-Coupon Yield Curves on November 30, 2007 Guarantees Maturity (years) Warranties Collateral for third-party 1 liabilities 2 Euro (German Govt. Bonds) 3.94 3.81 3 4 5 6 7 3.80 3.84 3.90 3.96 4.03 T 78 12,966 27,040 27,043 93,743 8 58,070 9 10 4.09 4.15 4.21 4.10 4.21 As a partner of Venture Capital Beteiligung GbR, Porsche AG is liable as provided for by law. US$ (US Treasuries) 3.19 3.04 3.08 3.23 3.43 3.62 3.80 Source: European Central Bank and Federal Reserve Board. 11 This document is authorized for use only by James Sexton in 2017. T 3.97 For the exclusive use of J. Sexton, 2017. Hedging at Porsche W04C40 Appendix G Share Prices of Volkswagen and Porsche July 31, 2007 November 30, 2007 Volkswagen (ordinary shares) 132.54 163.84 Porsche (preferred shares) 1341.00 1504.10 7 Volkswagen Porsche 6 DAX 5 4 3 2 1 11/3/07 9/3/07 7/3/07 5/3/07 3/3/07 1/3/07 11/3/06 9/3/06 7/3/06 5/3/06 3/3/06 1/3/06 11/3/05 9/3/05 7/3/05 5/3/05 3/3/05 1/3/05 0 Note: Volkswagen ordinary shares, Porsche preferred shares, and DAX Index (German stock market index), all rebased to 1.00 at the start of 2005, and adjusted for dividends and splits. Source: DataStream. 12 This document is authorized for use only by James Sexton in 2017. For the exclusive use of J. Sexton, 2017. Hedging at Porsche W04C40 Endnotes 1 Karaian, Jason. \"All Hail Holger Hrter.\" CFO.com. 13 Nov. 2007. Web. Accessed 22 June 2015. . 2 Milne, Richard. \"Porsche profits by CFO's hedges.\" The Financial Times. 29 Nov. 2007. Web. Accessed 22 June 2015. . 3 Porsche. Annual Report 2006/2007. Web. Accessed 22 June 2015. . 4 Porsche. Annual Report 2006/2007. 5 Nash, Nathaniel C. \"Putting Porsche in the Pink.\" The New York Times. 20 Jan. 1996. Web, Accessed 22 June 2015. . 6 Nash, Nathaniel C. 7 Thomas, Chad, and Jeremy van Loon. \"Porsche to Increase Volkswagen Stake Today, Make Takeover Bid.\" Bloomberg. 26 March 2007. Web. Accessed 22 June 2015. . 8 FinanzNachrichten.de. \"Porsche to Ask Shareholders to Approve Motion to Create Reserve Capital.\" 12 July 2006. Web. Accessed 22 June 2015. . 9 Karaian, Jason. 10 Landler, Mark. \"As Exchange Rates Swing, Carmakers Try to Duck.\" The New York Times. 17 Jan. 2004. Web. Accessed 22 June 2015. . 11 Wood, Duncan. \"Cautious Porsche.\" Risk. April 2006. 12 Wood, Duncan. 13 Wood, Duncan. 14 Landler, Mark. 15 The Economist. \"Keeping it in the Family.\" 29 Sep. 2005. Web. Accessed 23 June 2015. . 16 Milne, Richard. \"Porsche Plans to Acquire 20% Stake in VW.\" Financial Times. 26 Sep. 2005. Web. Accessed 23 June 2015. . 17 The Economist. \"Keeping it in the Family.\" 18 The Economist. \"Keeping it in the Family.\" 19 The Economist. \"Keeping it in the Family.\" 20 Lander, Mark. 21 Porsche. \"Porsche Requests Approval for an Increased Stake in VW.\" 23 June 2006. Web. Accessed 23 June 2015. . 22 Porsche. 26 March 2007. Web. Accessed 23 June 2015. \"Porsche AG Exercises Option with Regard to Ordinary Shares of Volkswagen AGStake in Ordinary Shares Increases to 30.9 Per Cent.\" . 23 Thomas, Chad, and Jeremy van Loon. 24 Reuters. \"Porsche Mandatory Bid for VW FailsAs Planned.\" 4 June 2007. Web. Accessed 23 June 2015. . 25 Milne, Richard. 26 Volkswagen AG Interim Report JanuarySeptember 2007. Web. Accessed 23 June 2015. . 27 Karaian, Jason. 28 Milne, Richard. 29 Karaian, Jason. 13 This document is authorized for use only by James Sexton in 2017. Hedging at Porsche For the exclusive use of J. Sexton, 2017. W04C40 Notes 14 This document is authorized for use only by James Sexton in 2017. Hedging at Porsche For the exclusive use of J. Sexton, 2017. W04C40 Notes 15 This document is authorized for use only by James Sexton in 2017. For the exclusive use of J. Sexton, 2017. Established at the University of Michigan in 1992, the William Davidson Institute (WDI) is an independent, non-profit research and educational organization focused on providing private-sector solutions in emerging markets. Through a unique structure that integrates research, field-based collaborations, education/training, publishing, and University of Michigan student opportunities, WDI creates long-term value for academic institutions, partner organizations, and donor agencies active in emerging markets. WDI also provides a forum for academics, policy makers, business leaders, and development experts to enhance their understanding of these economies. WDI is one of the few institutions of higher learning in the United States that is fully dedicated to understanding, testing, and implementing actionable, private-sector business models addressing the challenges and opportunities in emerging markets. This document is authorized for use only by James Sexton in 2017. BUSFIN 4255 International Finance Spring 2017 Semester Foreign Exchange Hedging Exercise Due at Start of Class, Friday, March 24th The Porsche case will handed out in class. Porsche elects to hedge foreign exchange risk up to three years forward using options. Exhibit 2 of the case shows the high level currency hedge exposures Porsche had as of the end of July 2006 and 2007. Assume the figures reported for 2007 consist of the following: Currency Hedge Assets (~12 billion) are puts giving the right to put USD and receive EUR. The puts have a strike price of 0.6897/$ (equal to spot rate) and an average term of 2-years. This is equal to $1.45/. 2-Year deposit rates in Germany are 4.5% and in the USA 5.5%. The annualized volatility of $/ is 10%. 1. Use the European Option Pricing model to estimate the total premium paid on 12 billion of put options. Be sure to calibrate the pricing model using the above parameters. 2. Again use the model to estimate the potential MTM change of this 12 billion portfolio of put options assuming the $/ exchange rate can vary from $1.25/ to $1.65/ in $0.10/ increments. Converted to /$ this is 0.8000, 0.7407, 0.6897, 0.6452, 0.6061. 3. Compare the option premium and simulated MTM to foreign sales figure of 3,940 in 2007. Assume this is all in USD ($5.713 billion at spot price of $1.45/) and represents the full exposure (no need to net local expenses). Determine how much FX risk Porsche has to this exposure by using the same variation in FX prices used in step #2. Opine whether or not the hedge is about right, too large or too small relative to USA sales. 4. Compare the simulated MTM to the 2007 Capital Allocated to Shareholders figure of 8.671 billion for 2007 as shown in Appendix A. Opine whether or not the hedge produces an immaterial, moderate or significant potential impact on the shareholder value of the company. 5. Consider and discuss other possible hedging strategies, including other financial strategies, operational strategies (such as BMW) or product pricing strategies (for example, if their products are relatively price elastic or inelastic, could you adjust price to hedge FX). Review the remaining part of the case, including Porsche's prospective takeover of VW. Based upon the discussion, including the profits derived from hedging vs. core operations, opine: 6. What should shareholders think about the sustainability of Porsche's income given the hedging activities? If you were a stock analyst how would you convey Porsche's currency and VW hedging activities to shareholders? This exercise should fit into a presentation of 6 or less pages. Please keep your responses short and pointed. Be sure to include a cover page with the class time and names of all students on the team