Dozier: Foreign Exchange Market and Forward Contract

Dozier Industries has leash picks to choose from when deciding on the best way to handle their first non-US dollar denominated due 1. immersion into a forward contract in which Dozier would shift forward British dumbfounds. 2. Execute a spot market transaction to create a synthetic forward dodge. 3. Do not hedge against any fluctuations in the midst of the Pound and the Dollar. For the purpose of the analysis, there be several assumptions made which are pertinent to the analysis that follows (see appendix). Forward Contract turn offThe first option available to Dozier Management to hedge the assay of the Great British Pound (GBP) depreciating against the United States Dollar (USD) is to enter into a contract to interchange forward ? 1,057,500 for USD in 90 days. Therefore, on April 14th, when Dozier set abouts the remaining GBP from the security ashes contract, it would be required to deliver these GBP to the counterparty of the forward contract. This option would make the tighten immune to any fluctuations in the value of GBP relative to USD everywhere the following(a) 90 days as the trusty would lock in the USD/GBP telephone exchange rate for their due of ? ,057,500. At the incumbent 3-month forward rates of (1. 4198 USD/GBP), Dozier would let guaranteed proceeds of $1,501,438. 50. Dozier also received ? 117,500 as submit for the contract. The firm could sell this set up on the spot foreign exchange market at the current rate of 1. 437 USD/GBP and receive $168,847. 50. Investing the proceeds of the deposit in a U. S. money market account would yield $171,988. 00 in 90 days. It is important to note that since the contract was settled on December 3rd, the GBP depreciated by over 3% (from (1. 820 to 1. 437 USD/GBP). As a result of this movement, the USD value of the deposit was reduced by the same 3% from $174,135. 00 to $168,847. 50. Under the strategy of use the forward contract hedge, the firm would be assured of receiving a entire of $1,673,426. 50 ($1,501,438. 50 plus $171,988. 00). Given the total cost of the view of $1,642,783, the firm would insure a lucre of $30,643. 50, a margin of 1. 87%. This profit margin would be signifi quartertly below the projected 6% return. Spot foodstuff HedgeAn alternative to the forward contract hedge is Dozier could create a matching liability for the GBP receivable by borrow GBP from the bank, immediately exchanging the GBP for USD in the spot foreign exchange market and therefore investing the USD proceeds in a three month deposit. At the time the receivable comes due, Dozier would use the GBP proceeds to repay the liability and conceal the USD amount of the three month profit. These series of transactions would eliminate the risk of the depreciation of the Pound. GBP funding is available at a rate of 15% (13. 50% GBP prime rate plus 150 basis dismantle credit spread).To create a GBP liability of ? 1,057,500 GBP in 90 days, the firm would need to borrow its prese nt value of ? 1,021,188. 50. The firm would then receive $1,467,447. 88 at the current exchange rate. As the USD investment would be over $1. 0 million it would be classified as a large deposit and qualify for the premium interest rate. As in the previous scenario, Dozier would immediately exchange the ? 117,500 deposit into $168,847. 50. The total proceeds of $1,636,295. 38 could then be invested in a deposit bearing 8%, earning interest of $31,787. 57 over 90 days. The firm would receive a total of $1,668,082. 4 from the initial deposit, the principle and interest in the three month investment. Given the project costs stated above, the firm would realize a profit of $25,299. 94, representing a margin of 1. 54%. Spot Market Hedge The final option available to Dozier Management is to leave the 1,057,500 GBP receivable un-hedged. If the GBP were to appreciate against the USD over the next 90 days, Dozier would reap the full value of this appreciation. Conversely, should the GBP depr eciate versus the USD over the next 90 days, Dozier would suffer a sack equal to the percent depreciation of the pound to the dollar.In a scenario where the USD/gross domestic product exchange rate moves by 10%, the Doziers profits would dress between negative $96,471. 13 (or 5. 9% of cost, making the project a dismissal) and $207,819. 16 (or 12. 65% of cost, effectively doubling the profit margin). Conclusion Dozier can capture a profit through both of the hedging strategies albeit it cosmos smaller than the target six percent originally built into the bid. An un-hedged send is unacceptable due to the firms recent financial difficulties it is vital that Dozier profits from this initial venture into this new market.While leaving the receivable un-hedged alternative does offer the greatest potential profit at the current prevailing FX rates, these profits are not guaranteed (see appendix for profit/loss possibilities given GBP/USD FX fluctuations). Given the importance of lock ing in a profit and the uncertainty of the GBP/USD future exchange rates, we recommend Dozier hedges the ? 1,057,500 receivable by exchange rate in Appendix Assumptions All transactions are kill immediately. All transaction costs surrounding the forward contract are negligible. All rates given in Exhibit 4 testament not fluctuate over the 90 day time span. puts over $1 million are eligible for the three month deposit rate. Calculation of pays Spot Market Hedge desex nitty-gritty $ 168,847. 50 Interest Received $ 28,507. 45 Principal Amount $ 1,467,447. 88 Total $ 1,664,802. 82 Cost of Project $ 1,642,783. 00 Interest on initial Deposit $ 3,280. 12 Net Profit on Project $ 25,299. 95 Profit Margin on Project1. 54% Currency Forward Hedge Receivable GBP $ 1,057,500. 00 Short GBP $ (1,057,500. 00) Long USD 3 month Fwd $ 1,501,438. 50 Deposit $ 168,847. 50 Cost of Project $ 1,642,783. 00Interest on Initial Deposit $ 3,140. 50 Net Profit on Project $ 30,643. 50 Profit Margin on Proje ct1. 87% Profit Margin Scenario Analysis FX grade% ChgUSD EquivalentCost of ProjectDepositProfit/LossProfit Margin 1. 30 -10. 0% $ 1,374,323. 87 $ 1,642,783. 00 $171,988. 00 $ (96,471. 13)-5. 87% 1. 31 -9. 0% $ 1,388,205. 93 $ 1,642,783. 00 $ 171,988. 00 $ (82,589. 07)-5. 03% 1. 33 -8. 0% $ 1,402,228. 21 $ 1,642,783. 00 $ 171,988. 00 $ (68,566. 79)-4. 17% 1. 34 -7. 0% $ 1,416,392. 13 $ 1,642,783. 00 $ 171,988. 0 $ (54,402. 87)-3. 31% 1. 35 -6. 0% $ 1,430,699. 13 $ 1,642,783. 00 $ 171,988. 00 $ (40,095. 88)-2. 44% 1. 37 -5. 0% $ 1,445,150. 63 $ 1,642,783. 00 $ 171,988. 00 $ (25,644. 37)-1. 56% 1. 38 -4. 0% $ 1,459,748. 11 $ 1,642,783. 00 $ 171,988. 00 $ (11,046. 89)-0. 67% 1. 39 -3. 0% $ 1,474,493. 04 $ 1,642,783. 00 $ 171,988. 00 $ 3,698. 04 0. 23% 1. 41 -2. 0% $ 1,489,386. 91 $ 1,642,783. 00 $ 171,988. 00 $ 18,591. 91 1. 13% 1. 42 -1. 0% $ 1,504,431. 23 $ 1,642,783. 00 $ 171,988. 00 $ 33,636. 2 2. 05% 1. 44 0. 0% $ 1,519,627. 50 $ 1,642,783. 00 $ 171,988. 00 $ 48,832. 50 2. 97% 1. 45 1. 0% $ 1,534,823. 78 $ 1,642,783. 00 $ 171,988. 00 $ 64,028. 77 3. 90% 1. 47 2. 0% $ 1,550,172. 01 $ 1,642,783. 00 $ 171,988. 00 $ 79,377. 01 4. 83% 1. 48 3. 0% $ 1,565,673. 73 $ 1,642,783. 00 $ 171,988. 00 $ 94,878. 73 5. 78% 1. 50 4. 0% $ 1,581,330. 47 $ 1,642,783. 00 $ 171,988. 00 $ 110,535. 47 6. 73% 1. 51 5. 0% $ 1,597,143. 77 $ 1,642,783. 00 $ 171,988. 00 $ 126,348. 77 7. 69% 1. 3 6. 0% $ 1,613,115. 21 $ 1,642,783. 00 $ 171,988. 00 $ 142,320. 21 8. 66% 1. 54 7. 0% $ 1,629,246. 36 $ 1,642,783. 00 $ 171,988. 00 $ 158,451. 36 9. 65% 1. 56 8. 0% $ 1,645,538. 83 $ 1,642,783. 00 $ 171,988. 00 $ 174,743. 83 10. 64% 1. 57 9. 0% $ 1,661,994. 22 $ 1,642,783. 00 $ 171,988. 00 $ 191,199. 22 11. 64% 1. 59 10. 0% $ 1,678,614. 16 $ 1,642,783. 00 $ 171,988. 00 $ 207,819. 16 12. 65% Notes *All numbers rounded to the nighest one-hundredth decimal place. *No probability weighting given to to each one scenario.