SynClear Ltd$,$ of Seattle, Washington, produces equipment to clean polluted

waters. It has a subsidiary in Canada that imports and markets its parent$$s

products. The value of this subsidiary, in terms of Canadian dollars $($CAD$),$ has

recently decreased to CAD $5$ million due to the depreciation of the CAD relative to

the US dollar $($USD$)-$ from the traditional level of USD$/$CAD $0\mathrm{.}85$ to about $0\mathrm{.}75.$

SynClear$$s analysts argue that the value of the CAD may very well return to its

former level if$,$ as seems reasonable, the uncertainty created by Canada$$s rising

government deficit is resolved. If the CAD recovers, SynClear$$s products would be

less expensive in terms of CAD, and the CAD value of the subsidiary would rise to

about $6\mathrm{.}5$ million.

Required:

i$.$ From the parent$$s $($USD$)$ perspective, is the exposure of SynClear Canada

to the USD$/$CAD exchange rate positive or negative? Explain the sign of

the exposure. $(6$ marks$)$

ii$.$ Determine the exposure and verify that the corresponding forward hedge

eliminates this exposure. Use a forward rate of USD$/$CAD $0\mathrm{.}80,$ and

USD$/$CAD $0\mathrm{.}75$ and USD$/$CAD $0\mathrm{.}85$ as the possible future spot rates. $(8$

marks$)$

iii. SynClear$$s chairman argues that, if the exposure is positive and the

possible exchange rate change is an appreciation of the CAD, the only

possible change is an increase in the value of the subsidiary. Therefore, he

continues, the firm should not hedge: why give away the chance of gain?

How do you evaluate this argument? $(6$ marks$)$