Case #37 Baker Adhesives Case Study Teacher's Notes Essay

4782 Words Apr 19th, 2011 20 Pages

Teaching Note

Synopsis and Objectives

Baker Adhesives (Baker) has just made its first foray into international sales and must come to grips with the impact of exchange-rate changes on the profitability of a past order. The company must also formulate a strategy for dealing with exchange-rate risks for future orders. The case is intended as an introduction to exchange-rate risk and the management of that risk. Upon receipt of payment from a past order, the firm realizes that exchange-rate movements have reduced the value of the sale. A follow-on order provides the context for exploring possible mechanisms for managing that risk. In particular, sufficient direction and information is provided to examine both a
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As part of this analysis, the students will also calculate an expected amount without any hedging. The calculation implies an extremely small cost of eliminating the currency risk—a typical result and an important moment of insight for the students.

4. Why do we see a preference for the forward-market hedge over the money-market hedge?

This portion of the class can be expanded or limited depending on the guidance of the instructor during class. A discussion of parity conditions can be useful, but can also pull the class off track. The preference arises out of the unique borrowing costs presented to Baker. The bank affiliate in Brazil is charging a higher credit spread to Baker than in Baker’s domestic borrowing market. This is another important insight moment—imperfections in the markets will generate preferences.

5. With the forward or money-market hedge in place, can the company be completely sure there will be no exchange risk?

This discussion is quite important. The financial hedges are created under the assumption that the cash flow will be received by the customer on a specific date. There are, in fact, a number of residual risks that make the hedge less than perfect. This will come as a surprise to many students.

6. Should Baker accept the new order?

At first, the order appears to be unprofitable; however, the students can be pushed to think more carefully about the

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