Baker Adhesives Case
So, in this approach, the payment 156,507.45 BRL would be converted to be 66,155.70 USD by forward rate (0.4227 USD/BRL) and future value of payment in USD would calculated as present value by three-month loan rate in USA 2.1452% over 3 months. Then the present value of the payment would be 64,766.33 USD as showing in Figure 2.
Figure 2: Hedge in forward market
Hedge in The Money Market
According to the case, Brazilian bank offer short-term loan in BRL currency with rate 6.5% over 3 months. So that, the payment 156,507.45 BRL would equal to 146,955.35 BRL in present value by loaning from Brazilian bank and it would converted by current bid on real rate of US bank 0.4368 USD/BRL. Thus, the present value of the payment would be 64,190.10 USD as showing in Figure 3.
Figure 3: Hedge in money market
After calculating, the present value of the payment that would receive 3 months after order placement from Forward Market Hedge approach was 64,766.33 USD and the present value from Money Market Hedge approach was 64,190.10 USD. Both of 2 risk management tools were not help Baker to have a profit from this order, because the present value were lower than total cost of 1,815 gallons (67,969 USD). On the other words, cash inflow was lower than cash outflow or net present value was …show more content…
However, if Baker would take the risk of future exchange rate, they might got 66,265 USD calculated by consensus forecast bid rate for September 5, 2006 at 0.4368 USD/BRL. This amount also not covered the total cost and the firm had to take the risk of monthly exchange rate changing around 6.53% (Standard Deviation of monthly exchange rate changes).
Consequently, Baker should not accept this new order if Novo not agree with new per-gallon price according to exchange rate changing and increasing of raw material costs. Therefore, Baker should make new price agreement with Novo and the price should cover all the costs including the cost of exchange rate risk. Since, Baker had to compete with their competitors, and they charge only 8% for profit margin. Then, a little of exchange rate fluctuation would threat Baker’s profitability. Hence, Baker should set up the price carefully when doing business with oversea