You are just one week ‘young’ in your job as a treasury executive in a leading laptop trader/supplier in India. Earlier your company was sourcing assembled laptops from China, but with the incentives provided in the Budget of 2006 by the Finance Minister of India, your company is planning to enter assembly/manufacturing market in India.
Now, your company is planning to source components and sub assemblies from Taiwanese firms. This will involve a lot of foreign exchange trading and contracts.
Since you are from a leading business school in India, your CFO has asked you to make a presentation to the top management on various possibilities relating to forex market in India.
What is all that you would like to tell the top management so as to establish your credibility?
While you are making presentation to the top management a middle aged person enters the boardroom. All the board members exchange smiles with this person.
At the end of your presentation, this new entrant speaks up, “Well, that was a very interesting presentation. It appears that you know a lot about forex markets in India.” This person continues, “While, I was on flight today, I came across an interesting bit of information. There was a story in the newspaper mentioning that one can make a ‘killing’ in forex market, if one is smart enough. I feel that you should tell us about this ‘killing’ business as well.” And goes on to add with a smile and tinge of sarcasm, “I guess this will make our treasury a ‘profit center’”. All the board members nod in unison. The chairman takes out the day’s paper and hands it over to you to examine the possibility of making a ‘killing’ in the market.
Sweat breaks on your eyebrows. You do not remember having seen newspaper quotes during your course work, since you devoted the majority of your time during MBA days to cultural activities and student exchange programmes. This is going to be your first real challenge in the industry. You ask for some time to examine the numbers. The chairman and CFO give you patronizing looks and ask you to come back after a working lunch and tell the board about your findings. As you come back to your desk, you feel sudden loss of appetite.
After a while, the same person walks up to your desk and says, “I can understand your predicament. I know you are fresh from your MBA, and just one week young with our company. I hope these numbers help you to present your case”, while handing over a piece of paper to you. You do not like the patronizing tone. You thank this person for encouragement (!). You find following details staring at you.
USD/CHF : 1.5963/1.5973. This is a quote available from a bank in Zurich. At the same time, a bank in New York is offering the following spot quote: CHF/USD : 0.6265/0.6270
Further, a New York bank is currently offering these spot quotes:
USD/JPY : 112.25/112.55 and USD/AUD : 1.6659/1.6672
At the same time, a bank in Sydney is quoting :
AUD/JPY : 68.80/68.97
Additionally, the following pair of spot and forward quotes are also available:
GBP/USD spot : 1.6531/1.6600 and
GBP/USD 1-month forward : 1.6566/1.6577
Hope this helps!
What will you do next? How will you present your analysis?
You are back to your office after a long holiday in Caribbean Islands with your family members. This was a gift for your outstanding performance last year. Your predictions about exchange rate and interest rates were bang on target. This forecast helped your company to save over a hundred million dollars. Your CEO wants you to replicate this performance this fiscal. You have promised your daughter and your spouse that you will be taking them to Amazon forests for white water rafting next year.
Your company is the largest cloth manufacturer in the world in your segment. You are planning forays into the branded garments segment. Since you want to keep transportation costs at their minimum, you are planning to set up manufacturing bases in all the major markets. Think Global –Act Local’ is your mantra, as well.
Plant and Machinery
It is expected that your three plants will be set up in Mexico, Brazil, and Australia. These plants will have about the same capacity and are likely to cost about USD ten million each. The construction period could be anywhere from two to five years, depending on the support received from local government officials. This investment could easily make your company the second largest manufacturer of cloth in that segment.
Your company has a choice of either setting up a 100% subsidiary or a joint venture with one of the local companies.
There are local political parties who can make life difficult in Brazil. However, in Mexico and Australia you are likely to sail smoothly.
There are no credible estimates for cashflow because the local markets are an uncharted territory for you. All you know is: you goods will be priced in local currency.
On this front, you have multiple choices: (i) raising domestic equity in rupee terms, (ii) mix of debt and equity in rupee terms, (iii) USD denominated bond issue, (iv) raising local currency debt.
Should your company make this investment? If yes, then which will be the best route to (a) maximiza-tion of profits, (b) minimizing risk, (c) finding the optional mix of profits and risk. What all information to you need to arrive at these answers? How will you structure your analysis?
“Ready for take off”, voice of the Captain crackles over announcement system and brings you back to present. You are returning after attending the glittering function where ‘DFO of the Year’ award was presented. While coming out of the function, you overheard someone saying, “That’s no big deal! If this person is really great then why not try and get the ‘Financial Engineer of Year’ award!!” The comment was definitely aimed at you, the winner of this year’s award.
Your company is one of the leading software companies in India, having a turnover of over USD 500 million in the last financial year. Now, for reasons best know to them, the board members are keen that the company should diversify into commodity trading. As you savour the gourmet meal, the aircraft starts shaking suddenly and an announcement is made, “We have hit an air-pocket. We expect more turbulence ahead. Please occupy immediately the nearest vacant seat available and fasten seat-belts for your safety.” There is near commotion in the cabin, and the next moment you find a middle-aged gentleman seated.” There is near commotion in the cabin, and the next to you whose face is familiar; you exchange greetings with each other.
You start talking and as the discussion builds up you find that the other person was also there during the presentation ceremony and he was, in fact, ‘Financial Engineer of the Year’ last year. He shows keen interest in your company and appears to know a lot about your company’s future plans. He offers to exchange you purchase of coffee worth USD 10 million options floating in return for sugar futures fixed, over next six months. You struggle to see the reason and remain non committal.
On your return to office you find that your company needs to enter into interest rate swap for its forthcoming commodity trading project. But this activity will be starting in about nine months from now and it will involve series of swaps, required to be settled every month for about JPY 100 million fixed against AUS dollar floating. This is coming from your overseas software business in these countries, where your company has taken a perpetual loan from the local banks due to the Government’s policy to demonstrate that you have long term business interests in those countries.
You are keen to manage the risk of your foreign currency receivables portfolio, typically in EUR, with variable timing by having a cross currency swap with a hardware vendor from China. You have not yet decided about the currency which will be profitable against EUR.
While, you are in this process, your phone rings and the winner of ‘Financial Engineer of the Year’ award is on line asking you to join him for a dinner meeting next Friday. You sense that it could be good opportunity for you to learn a few things from him.
You have about ten days time on your hand, and you are keen to get ‘Financial Engineer of the Year” award next year.
How will you proceed to structure this situation? What all information will be needed? What is your perception of the risks involved in the proposed structure?
You are the chief financial officer of a leading dental hospital located in India. Your hospital has been having a roaring practice. You have a large group of dedicated doctors and a wide range of patients traveling from all over the region. Your hospital is known for its professional perfection and value-for-money services.
Of late the hospital has started offering services to relatively well off customers under ‘cosmetic dentistry’. The opening of this market segment has helped the hospital to reduce per patient charges for patients of ‘essential dentistry’. The hospital is also planning to start ‘mobile dental clinics’ to cover rural areas, in line with its motto ‘Oral Hygiene for All’.
While the Ministry of Public Health and Social Welfare is supporting the second initiative, the Ministry of Tourism and Hospitality is supporting the previous initiative along the lines of ‘Smile India’ campaign. This has helped India in becoming a preferred destination for the emerging market for ‘health tourism’. A majority of customers of cosmetic treatment are from Europe and the US of A. Recent interest of some of the corporate clients from Australia and some pop-divas has given your hospital practically free media coverage.
Expectedly, this success is not an unmitigated blessing. Competition in the region is coming from a Chinese dental hospital. They are offering ‘tooth’ transplant with the help of a Korean firm. This firm has asked a claim that they have the technology to organically grow a tooth with the help of root-canal cells taken from a patient. This is a time consuming and costly process and requires a longer stay in China and frequent visits to Korea, but patients do not seem to mind—since they are assured of an ‘organically’ grown tooth.
There is another competitor coming up in Belgium. They have a different technology. It is neither ‘organic’ nor as good as Indian, but highly cost effective since they fix an artificial tooth in a metallic socket, which can be removed and refitted without much effort.
However, in last few months, the dedicated lot of dentists with your hospital are also reading the media reports and there is growing feeling among them that the hospital is increasingly straying away from its path of ‘oral hygiene for all’. Some of the younger dentists have, on more than one occasion voiced their demand for higher compensation. Recently, a group of experienced dentists have taken up visiting positions with the Belgian hospital for a few weeks in a year. Now, the dentists have taken up visiting positions with the Belgian hospital for a few weeks in a year. Now, the dentists want a pay hike and that wages to be paid in USD, not in INR as was the practice so far.
Your CEO has asked you to see her with the possible scenario analysis in a month from now.
You have gone through all your cost sheets. You know that the costliest element is the special grade dental cement, which is to be imported in packs of 1000gm each costing over INR 1,000,000. Each tooth requires about 2gm of this secial grade cement. Adding other facilities and services, it costs INR 3000 per tooth for each ‘cosmetic’ treatment. Your charges are in the range of USD 200 which is very competitive in the international market. However, the Chinese-Korean combine is offering ‘organic’ tooth at USD 600 per tooth, all inclusive. The Belgian experiment is at about USD 30 per tooth, but has a shorter useful life.
When you look at your cash inflow you find that your earnings are in all possible currencies of the world but your costs are tied with USD and INR. The cover story of The Economist indicates possibility of USD appreciating against INR and other major currencies on account of successful resolution of the Iraq situation and peaceful resolution of the Iraq crisis, leading to the softening of world oil market prices. Though you are not a dentist by profession, you have a tooth in every possible profession! You have suggested to the chief dentist to explore the possibility of using heavy metal/precious metal with ceramic composite. You heard about this kind of material in your previous job while dealing with the Japanese Satellite Agency. The chief dentist was not very happy but promised to explore the possibility. You want to get into this material because there are commodity futures available on heavy/precious metals, while there is no way to cover ‘special grade cement’.
With this information on hand, you want to approach the Ministry of Public Health and Social Welfare and the Ministry of Tourism and Hospitality with a request to absorb price variation due to strengthening dollar. You have also approached RBI to grant permission to trade in futures in all the currencies in the world, but there are problems.
How will you guide your CEO in this situation?
Here are the ‘excerpts’ from a closed room discussion heads of purchase, marketing, production and the treasurer of Advanced Tectonic Devices. [The dialogues given below might appear to be unduly contrived to an expert. This was necessary for attaining clarity for our purpose and maintaining the printability of the statements; impolite usages are deliberately expunged.]
Head Marketing: See, after a long drawn effort, spread over six months, my boys and girls have managed to get this big #$%^*@ order totaling equivalent of USD 1.5 million. I had to @#$%^*& the happiness of all my staff to get this deal going. Despite an international competitive bidding we have got this order for the supply of high precision devices to the European Space Agency for the launch of a Japanese communication satellite. This supply agreement is likely to be signed in anytime over next two weeks. The exact rupee equivalent of this order will be known when the price is frozen, on the date of signing of contract.
Head Production: Thanks to all your efforts and advance planning, we are in a position to meet all deadlines, without an iota of problem. My only concern is about the raw material supply linkage. Give me material today and I will deliver the component without any problem in a matter of ten days. Add a cushion of two more days, if some rework in required due to material flaw. [Ends this sentence with a deprecating chuckle, obviously directed towards the head of purchase.]
Head Purchase: (He turns to Head Treasury) You production persons, when will you learn to behave. See, just before coming to this meeting I called the raw material supplier with our dates and quantity. He told me that material for entire order can’t be purchased in one lot due to international trade restrictions. This grade of alloy steel is on the international watch list due to possible use in nuclear weapons. Therefore, only a part of total material requirement can be bought at a time. As soon as one lot is consumed in production, we will need to issue a certificate to this effect, and then only the next lot of high alloy steel can be purchased. He turns to head treasury, See, the payment is to be made every fortnight for raw material (high alloy steel billets) over next six months, in equal installments of USD 100,000 each. Without fail! Any trouble on that front will jeopardize the entire supply sequence.
Head Marketing: As per the terms of contract, the buyer will be able to pay 50% of the contracted amount once the payload in fitted on the launch rocket in EUR (that is equivalent of USD 750,000) and the remaining 50% (that is equivalent of USD 750,000) immediately after launch of the satellite in JPY.
Head Treasury: [Definitely not amused] What is this @#$%& contract you have drawn. At least you *&%^$# should consult me before getting into any such commitments. Our chief economist is not comfortable with the world economy outlook. In her opinion, Japan appears to be heading towards yet another cycle of recession. EUR is likely to strengthen against JPY and USD over next six months. As far as INR is concerned, not much variation is expected over next months. And you expect me to do a profitable deal under the circumstances!! [Leaves the meeting room abruptly, door slams behind him, and some muffled shouts are heard]
Well, as you would have guessed it by now, you are the treasurer who feels slighted due to the process adopted by marketing, purchase, and production heads.
What are the choices available with you to meet these cashflow requirements? Analyze each possibility in detail and argue for and against each of them.
The first part of payment was received as planned. All are happy. The second part is due. The rocket is successfully launched but there is a problem. Since the time the communication satellite has been deployed, there has been a continuous decline in the bandwidth and transponder hire charges. Your counter party wants to renegotiate the terms of payment.
What will you do? How you will protect your interest in this situation?
1. A young financial analyst in Canadian firm has been assigned the task of evaluating a direct investment project in Mexico. She has worked out the operating cash flows of the project for the next 7 years For finding the NPV of the project she proposes the following four alternatives:
(a) Discount the nominal MEP (Mexican Peso) cash flows using the Mexican nominal interest rate used for similar projects and translate into CAD using the current MEP/CAD spot rate.
(b) Discount the real i.e. inflation adjusted MEP cash flows using the Mexican real interest rate and translate at the current spot rate.
(c) Forecast the MEP/CAD exchange rate for the next 7 years using PPP; translate nominal MEP cashflows into nominal CAD cash flows; discount using nominal CAD interest rate used for similar projects.
(d) Adjust the nominal CAD cash flows for Canadian inflation and discount using real Canadian interest rate.
Her boss says that if relative PPP and covered interest parity hold, the above alternatives would yield identical answers. Is he right? If not, can you correct him? Justify your answers with appropriate and sufficiently detailed arguments.
2. Consider a firm with a healthy cash flow but very low profits—because, for example, of high depreciation allowances. Your boss argues that such a firm should probably borrow in a strong (low-interest) currency, because the high-tax shield from weak-currency loans is more likely to be lost than the low tax shield from strong-currency loans. Is this analysis accurate?