On June 1, Novartis International AG, a global helathcare company based in Switzerland, sold a patent...

On June 1, Novartis International AG, a global helathcare company based in Switzerland, sold a patent for a chemical process to Bayer AG of Germany for €20.000.000, payables as €10.000.000 on September 1 and €10.000.000 on December 1. At the time Novartis quoted its price of €20.000.000 on May 1, the spot rate was CHF1,0668/€, resulting in a sales price of CHF21.336.000.

By the time the order was received and booked on June 1, the euro had strengthened to CHF1,0697/€, so the sale was in fact worth €20.000.000 x $1,0697/€ = CHF21.394.000. Novartis had already gained an extra CHF58.000 from favorable exchange rate movements. Nevertheless, Novartis’s director of finance now wondered if the firm should hedge against a reversal of the recent trend of the euro. Four approaches were possible:

1. Hedge in the forward market: The 3-month forward quoted was CHF1,0730/€ and the 6-month forward quote was CHF1,0718/€.

2. Hedge in the money market: Novartis could borrow euros from the Frankfurt branch of its Swiss bank at 6% per annum.

3. Hedge with foreign currency options: September put options were available with a strike price of CHF1,07/€ for a premium of 2,2% per contract, and December put options were available at CHF1,07/€ for a premium of 1,4%. September call options at CHF1,07/€ could be purchased for a premium of 3,3% and December call options at CHF1,07/€ were available at 2,3% premium.

4. Do nothing: Novartis could wait until the sales proceeds were received in September and December, hope the recent strengthening of the euro would continue, and sell the euros received for dollars in the spot market.

Novartis estimates its weighted average cost of capital to be 12%. Swiss T-bills yield 1% per annum.

What should Novartis do?

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jeff jeffy answered 1 year ago

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