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Vogl Company is a U.S. firm conducting a financial plan for

Vogl Company is a U.S. firm conducting a financial plan for the next year. It has no foreign subsidiaries, but more than half of its sales are from exports. Its foreign cash inflows to be received from exporting and cash outflows to be paid for imported supplies over the next year are shown in the following table:

Currency Total Inflow Total Outflow
Canadian dollars (C$) C$32,000,000 C$2,000,000
New Zealand dollars (NZ$) NZ$5,000,000 NZ$1,000,000
Mexican pesos (MXP) MXP11,000,000 MXP10,000,000
Singapore dollars (S$) S$4,000,000 S$8,000,000

The spot rates and one-year forward rates as of today are:

Currency
Spot Rate One-Year Forward Rate
C$ $ .90 $ .93
NZ$ .60 .59
MXP .18 .15
S$ .65 .64

1. Based on the information provided, determine the net exposure of each foreign currency in dollars.

2. Assume that today's spot rate is used as a forecast of the future spot rate one year from now. The New Zealand dollar, Mexican peso, and Singapore dollar are expected to move in tandem against the U.S. dollar over the next year. The Canadian dollarĂ¢??s movements are expected to be unrelated to movements of the other currencies. Since exchange rates are difficult to predict, the forecasted net dollar cash flows per currency may be inaccurate. Do you anticipate any offsetting exchange rate effects from whatever exchange rate movements do occur? Explain.

3. Given the forecast of the Canadian dollar along with the forward rate of the Canadian dollar, what is the expected increase or decrease in dollar cash flows that would result from hedging the net cash flows in Canadian dollars? Would you hedge the Canadian dollar position?

4. Assume that the Canadian dollar net inflows may range from C$20,000,000 to C$40,000,000 over the next year. Explain the risk of hedging C$30,000,000 in net inflows. How can Vogl Company avoid such a risk? Is there any tradeoff resulting from your strategy to avoid that risk?

5. Vogl Company recognizes that its year-to-year hedging strategy hedges the risk only over a given year, and does not insulate it from long-term trends in the Canadian dollarĂ¢??s value. It has considered establishing a subsidiary in Canada. The goods would be sent from the U.S. to the Canadian subsidiary and distributed by the subsidiary. The proceeds received would be reinvested by the Canadian subsidiary in Canada. In this way, Vogl Company would not have to convert Canadian dollars to U.S. dollars each year. Has Vogl eliminated its exposure to exchange rate risk by using this strategy? Explain.

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SOLUTION

1. Based on the information provided, determine the net exposure of each foreign currency in dollars.
To do this we use spot exchange rate:
For example with Canadian dollars:
Net exposure = Total inflow - Total outflow = C$32,000,000 - C$2,000,000 = C$30,000,000 (Net Inflow).
Therefore we have this net exposure converted to USD as follows:
C$30,000,000 * $0.9USD/$1CAD = USD$27,000,000 (Inflow)
Similar calculations can be done as demonstrated in the table below.

Currency

Net Inflow or Outflow Spot Rate
Net Inflow or Outflow
in USD
Canadian dollars (C$) C$30,000,000 Inflow $.90 $27,000,000 Inflow
New Zealand dollars (NZ$) NZ$4,000,000 Inflow .60 $2,400,000 Inflow
Mexican pesos (MXP) MXP1,000,000 Inflow .18 $180,000 Inflow
Singapore dollars (S$) S$4,000,000 Outflow .65 $2,600,000 Outflow

2. Assume that today's spot rate is used as a forecast of the future spot rate one year from now. The New Zealand dollar, Mexican peso, and Singapore dollar are expected to move in tandem against the U.S. dollar over the next year. The Canadian dollar's movements are expected to be unrelated to movements of the other currencies. Since exchange rates are difficult to predict, the forecasted net dollar cash flows per currency may be inaccurate. Do you anticipate any offsetting exchange rate effects from whatever exchange rate movements do occur? Explain.

The ...

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