This is a Darden case study. An undersized adhesives firm is challenged with the threat of the exchange-rate risks as it takes beginners steps into global operations. The receiving of payment from an unpegged foreign currency labeled a previous sale transaction demonstrated possible risks associated with currency whereas a possible follow-on order makes room to talk about potential hedges. Further depth is given to the case with the fact that the follow-on sale seems to be without a profit unless the assessment takes into account the insignificance of the overhead costs and that the raw material's market value is less than the recorded value.
PV of expected cash flows
Hedging using forward market
Hedging with money market
How profitable is the original sale to Novo once the exchange-rate changes are acknowledged? How might the exchange-rate risk, which affected the value of the order, have been managed?
Assuming Baker agrees to the new Novo sale, determine the present value of the expected future cash inflow assuming: (1) there is no hedge, (2) the company hedges using a forward contract, and (3) the company hedges using the money market. Finding a present value is necessary for the following reason: With no hedge or a with forward-contract hedge, the cash flow will occur at the time of payment by Novo. With the money-market hedge, Baker receives a cash flow immediately.
Are the money markets and forward markets in parity?
How profitable will the follow-on order be? Would you make this new sale?