Stephanie Myers looked at her watch, it was 5:42, and she was still stuck at work. In her career as a professional accountant, she had never faced the challenges she currently did. She had recently been promoted to the Director of Finance role, at Precision Paper Club, a Magazine publisher. With several well-read magazines under its portfolio, the Precision Paper Club is considered to be a large player in the Magazine game, with yearly revenues reaching $3 Billion a year.

Stephanie's main concern has to do with Senior Financial Analyst, Aisha Prasad. Part of Aisha's responsibility is to oversee the firms risks related to Finance, However Aisha seems to be making very incompetent mistakes.

Stephanie has decided to send the VP of Finance, Bill Chung, an email, highlighting her issues with Aisha.

Cashflow related issues

Aisha is responsible for providing cash flow projections for the company. PPC has a significant amount of revenues in US Dollars, Euros, and Indian Rupees. In completing the cash flow projections, Aisha refuses to use current exchange rates, instead opting for the standard rates she adopted several years ago. For example, USD cashflow is being converted into CAD at 1.10 in her model. This causes the company to constantly underestimate the amount CAD cashflow from USD sourced revenue, since currently 1 USD is worth $1.35 CAD.

Foreign Exchange Hedging

Last year we made a major advertising campaign sale to a customer in Europe for 5 Million Euros. The cash was to be received 12 months after the sale date. On Aisha's recommendation, we got into a forward contract with the bank. If we hadn't gotten ourselves into the forward contract, we would have been much better off. As it turned out, the Euro appreciated greatly. The forward rate with the bank resulted in us only receiving $7 Million Canadian Dollars, whereas we would have received $9 Million CAD if we hadn't hedged.

Convertible Bonds

PPC has $10 Million in investment bonds with GPC, an industrial chemical supplier. Earlier this year, the $10 Million in bonds could have been converted into 50,000 common shares at a conversion price of $200/Share. At the time, GPC's stock was trading at $206/Share (greater than the conversion value). The 5% annual Coupon bonds had a yield of 4.5% at the time, with 4 years left. I believe PPC chose not to convert based on Aisha's recommendation.

Paper Price Hedging

A major concern at PPC is the rising price of Glossy Paper used in Magazines. To hedge against this concern, PPC has taken the short position in the futures market, on 1,000,000 contracts of Glossy Paper. I'm a bit concerned about this as the price of paper has gone down for 6 straight years. I honestly don't think this type of hedging is necessary for us.

Warrants

Aisha has suggested the use of Warrants to help decrease the coupon rate of the bonds we are planning to issue next year. Currently we are looking at raising $100 Million using 20 Year bonds. Currently the coupon rate is going to be 4%, however Aisha's analysis shows that if we were to include a warrant per bond (Each bond has a par value of $1000), then we could potentially decrease the coupon rate to 3.8%. The warrants will have a strike price of $50/Share with a 5-year expiry, and currently our shares are only trading at $40/Share. Similar warrants trade at about $2. I do not think that the value given away with the warrants justifies the lower cost on the bond.

Credit Policies

Aisha has proposed several credit policies which are extremely costly. Checking every customer's credit and references is just not good for business. A lot of our customers are small distributors who do not have the necessary time to comply with these requests. We have had very little bad debt so its unnecessary. The sales managers find the process lengthy and time consuming.

Required

Complete the questions below, with short descriptive qualitative answers, diagrams with explanations etc. Your answer should be short and concise, from one word to a few lines. You may answer in bullet form unless otherwise stated. Each question is worth the stated value.

A) Analyze each underlined heading and determine if Stephanie is correct in pointing out a mistake made by Aisha. (Total 36 Marks, 6 Sections, 6 Marks each)

B) Identify financial risks mentioned in the case. For each risk, provide an explanation of why you think it's a risk, and how the risk could hurt the company. MAXIMUM 4 RISKS. Total 24 Marks.

C) For each risk that you have highlighted in Step A, suggest a short-term hedging strategy. You should mention what instrument you would use to hedge, what position you would take, and why it would benefit the company? Total 20 Marks.

D) Why didn't Aisha consider the counter-party risk that the future market contains? 10 Marks.

E) Explain how market volatility effects the prices of stock options. 10 Marks.