Question

Mauna Loa Macademia. Mauna Loa Macadamia, a macadamia nut subsidiary of Hershey's with plantations on the slopes of its namesake volcano in Hilo, Hawaii, exports macadamia nuts worldwide. The Japanese market is its biggest export market, with average annual sales invoiced in yen to Japanese customers of 1,200,000,000 yen. At the present exchange rate of 125/, this is the equivalent to $9,600,000. Sales are relatively equally distributed throughout the year. They show up as a 250,000,000 yen account receivable on Mauna Loa's balance sheet. Credit terms to each customer allow for 60 days before payment is due. Monthly cash collections are typically 100,000,000 yen. Mauna Loa would like to hedge its yen receipts but it has too many customers and transactions to make it practical to sell each receivable forward, it does not want to use options because they are considered to be too expensive for this particular purpose. Therefore they have decided to use a "matching" hedge by borrowing yen.

A: How much should Muana Loa borrow in yen?

B: What should be the terms of payment on the yen loan?

Answer 1

ANSWER

A. How much should Mauna Loa borrow in yen?


Mauna Loa receives cash collections of one hundred million yen per month. This is the source of repayment of any
balance sheet hedge. If Mauna Loa  wants to be covered for one year at a time, it would need to borrow one year's
cash flow plus interest, and convert the borrowed yen to US dollar at once. A sample calculation would be:


Sample Values Units
One month's cash flow * 100,000,000 Yen
Months per year * 12
One year's cash flow * 1,200,000,000 Yen
Plus interest 4.000% per annum
Principal and interest * 1,248,000,000 Yen
Spot exchange rate * 125.00 Yen/US$
US dollars $9,984,000 US$


Realistically, Mauna Loa  would probably want to be covered for the long term. In that case, the 1.2 billion yen loan
could be structured so that it could be renewed annually with interest reset annually. This would only cover the
foreign exchange and interest rate risk for a year at a time, but would probably be acceptable to a bank lender.
Also unknown are the expected sales for year 2 and beyond.

B. What should be the terms of payment on the yen loan?


The loan should be repaid out of the monthly cash flow, with payments on principal only. The interest payment one
year hence has already been covered by borrowing both principal and interest up-front.


Note: Mauna Loa should not borrow 250 million yen to cover only its balance sheet exposure. Such a loan would cover
only the accounting exposure, and not the cash flow exposure (operating exposure).