Question
1. Why do you think the firms CEO has singled out the currency exchange rate as one of the major factors for the erosion in EPS?
2. Explain to your CEO the similarities and differences between hedging with options and futures contracts.
3. Being a producer of CPO, in what situations should Bersatu Plantations Berhad hedges its position?
4. Is FCPO or FUPO better for Bersatu Plantations Berhad? Explain your answer.
5. Explain why Bersatu Plantations Berhad may experience adverse results in hedging compare to non- hedgers from a similar industry.
6. Explain how currency derivatives may be helpful to Mr. Jeratin in dealing with currency valuations. Explain your answer with a specific example.
Corporate Hedging-the Use of Futures Contracts "We must come out with some drastic measures to improve the financial results for 2009 and beyond. It is time for us to start having a hedging policy, we cannot afford to let this company unprotected any longer." said the CEO of Bersatu Plantations Berhad. The CEO is turning his eyes to Mr. Jeratin, who joined the company more than a year ago. Previously, Jeratin was serving as an executive of product development unit at the Kuala Lumpur Derivatives Exchange. He has vast experience the mechanics of option and futures contracts trading Bersatu Plantations Berhad prides itself as one of the leading palm oil producers in the country, exporting crude palm oil (CPO) to many countries. Like so many other commodities, the CPO in the international market is priced in US dollar. Over the past few years, the company has witnessed a tremendous growth in the volume sales of CPO. The company's shareholders, however, are grumbling as the growth in the volume sales did not translate to same level of growth for the EPS. According to the CEO, one of the major contributing factors to the unimpressive EPS result is the appreciation of local currency against the U.S. dollar (USD) since the removal of currency pegging regime On July 21, 2005, Bank Negara Malaysia (BNM), the country's central bank, announced the end of the peg of Ringgit Malaysia (RM) to the US dollar immediately after China's announcement of the end of the renminbi peg to the USD. According to BNM, the country will now allow the RM to operate in a managed float against several major currencies Since the replacing of the currency-pegging regime with a managed float regime, the value of the RM has risen closer to its perceived market value, although Bank Negara has intervened in financial markets to maintain stability in the trading level of the RM. The RM appreciated to as low as RM3.16 to the USD in April 2008. The exchange rate of the RM against the USD over the past five years is illustrated in the following table. 2004 2006 2007 2008 RM3.8000 RM3.7872 RM3.6669 RM3.4356 RM3.5525 Source: x-rates.com (12 February 2009) Mr. Jeratin explains to the CEO that other than currency exchange volatility, the firm must also pay attention to price fluctuation of CPO Like many other commodities, the CPO trading in the international markets is participated not just by genuine producers and users of the commodity, but also by speculators and arbitragers. As such, the prices of CPO are anything but certain. He points out that prices of CPO can be hedged using Crude Palm Oil Futures (FCPO) and USD Crude Palm Oil Futures (FUPO). The details of these contacts are available from the official Website of Bursa Malaysia. Bursa Malaysia is presently not offering options on the CPO Before using futures contracts as the hedging tools, Mr. Jeratin strongly suggest that company executives who will be involved in the hedging policy and decision makings to equip themselves with knowledge in its usage. Like company shares, trading of the FCPO and FUPO is published in most major newspaper. A sample copy of which is distributed to all attendees at the meeting (please refer Figure 1) Before the meeting is adjourned, Mr. Jeratin is cautioning the members of the Board that the purpose of hedging is merely to reduce related risks. Comparing to non-hedgers in the similar industry, Bersatu Plantations Berhad may be experiencing relative disadvantages when the market moves adversely against its expectations. He further reminds the Board members that hedging in itself will cause additional risks on the firm. He terms this the basis risks. BURSA MALAYSIA DERIVATIVES EXCHANGE: NOVEMBER 11 THE CRUDE PALM OIL FUTURES CLOSING ALL PRCS ARE IN RM/MT CONTRACT OPEN HIGH LOW LAST VOLUME CHANGE (RM) (RM (RM DONE (RM) NOV 2009 2175 2175 2175 2175 5 +1 DEC 2009 22342238 2205 2215 830 -9 JAN 20102251 2260 2225 2234 3349 8 FEB 2010 2261 2278 2243 2255 730 5 MAR 2010 2260 2370 2255 2271 53 1 Information prepared by Innosabah Options Futures Sdn Bhd For information, please contact Tel: 088-267163 or email: ifsb@innosabah.com.my Resistance 1 Resistance 2 2300 2400 Support 1 Support 2 2100 2000 The purpose of this commentary is only to provide information from what we believe to be reliable sources. Innosabah Options Futures Sdn Bhd does not guar- antee its accuracy and will not responsible for any action taken by anyone based on the content of commentary Figure 1: Source: Daily Express dated 12 November 2009, page 26
