Question
Wholebean is a food and beverage company that concentrates on the coffee and cocoa markets. The company has exposure to coffee and cocoa on the
Wholebean is a food and beverage company that concentrates on the coffee and cocoa markets. The company has exposure to coffee and cocoa on the commodities markets. Annually the company uses 100 million of coffee and 50 million of cocoa.
The two commodities have exhibited greater volatility recently and the monthly volatility of coffee is 0.11547 and for cocoa the monthly volatility is 0.1010363.
Required:
(a) Calculate the individual and total value at risk (VAR) for Wholebean for its six- month planning period if the company has a 1.9 standard deviation confidence
limit.
The company is concerned with the increased volatility in the commodity markets for its main raw materials and feels that if it can reduce its overall risk by gaining exposure to another commodity it should do so.
The company is looking at two areas, sugar and soyabeans. It will only choose one, and will use 40 million of the commodity.
Sugar has a monthly volatility of 0.043301 and for soya beans it is 0.07216878.
The correlations between the commodities is: if sugar is chosen; coffee-cocoa 0.75, coffee-sugar 0.2, cocoa-sugar 0.25. If soya beans is chosen ; coffee-cocoa 0.75, coffee- soyabeans 0.3 (minus 0.3), cocoa-soyabeans 0.25 (minus 0.25).
(b) What is the VAR for each of the new commodities if chosen? Which would be choosen to reduce the VAR facing the company? What is the new VAR figure for
the three commodity portfolio? Comment briefly on the findings.
(c) Explain what the costs of financial distress are and, using the examples of a discount supermarket company and a furniture retailer company, discuss the nature of these costs assuming both companies are about to enter a financially distressed condition.
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