Question

Suppose that you are part of the Management team at Porsche. Suppose that it is the end of December

2019 and a novel coronavirus that causes a respiratory illness was identified in Wuhan City, Hubei

Province, China. The illness was reported to the World Health Organization and there is heightened

uncertainty around the Globe.

You (as part of the management team) are reviewing Porsche’s hedging strategy for the cash flows it

expects to obtain from vehicle sales in North America during the calendar year 2020. Assume that

Porsche’s management entertains three scenarios:

Scenario 1 (Expected): The expected volume of North American sales in 2020 is 35,000 vehicles.

Scenario 2 (Pandemic): The low-sales scenario is 50% lower than the expected sales volume.

Scenario 3 (High Growth): The high-sales scenario is 20% higher than the expected sales volume.

Assume, in each scenario, that the average sales price per vehicle is $85,000 and that all sales are

realised at the end of December 2020. All variable costs incurred by producing an additional vehicle to

be sold in North America in 2020 are billed in euros (€) and amount to €55,000 per vehicle. Shipping

an additional vehicle to be sold in North America in 2020 are billed in € and amount to €3,000 per

vehicle.

The current spot exchange rate is (bid-ask) $1.11/€ - $1.12/€ and forward bid-ask is $1.18/€ - $1.185/€.

The option premium is 2.5% of US$ strike price, and option strike price is $1.085/€. Your finance team

made the following forecasts about the exchange rates at the end of December 2020:

• bid-ask will be $1.45/€ - $1.465/€ if the investors (and speculators) consider the euro (€) a safe

haven currency during the pandemic.

• bid-ask will be $0.88/€-$0.90/€ if the investors (and speculators) consider the U.S. dollar ($) a

safe haven currency during the pandemic

1. As the CFO, you decided to hedge using option contracts. Assuming expected final sales

volume is 35,000, what are your total revenue and the percentage revenue from hedging

(compared to no hedging) (do not use any variable costs to calculate in this question)

a) if the exchange rate (bid-ask) remains at $1.11/€ - $1.12/€?

b) if the investors consider the U.S. dollar a safe haven currency during the pandemic?

2. Assume that the Scenario 2 (Pandemic) took place in 2020 and the euro became a safe haven

currency during the pandemic. What are your euro cash flows if you did not hedge, hedged

using forward contracts, and hedged using option contracts?

Answer 1

Given Below is Screenshot of Excel In which The given information has been drafted for calculation Purpose.

Calculations For above

step 1 .

q1

Assuming expected final sales

35000

Calculation of sales value to compare

if the exchange rate (bid-ask) remains at $1.11/€ - $1.12/€?

1$=0.8929Euro

=35000*85000*0.8929

(units)*$*Euro

=2656250000Euro

if the investors consider the U.S. dollar a safe haven currency during the pandemic?

1$=0.6826Euro

35000*85000*1.1111

=3305555556 Euro

%age =3305555556-2656250000

=649305556/2656250000

=24.44%

Higher by 24.44%

NOw lets answer The questions:

Please refer the table for convenience

1Assuming expected final sales

volume is 35,000, what are your total revenue and the percentage revenue from hedging

(compared to no hedging)

a) if the exchange rate (bid-ask) remains at $1.11/€ - $1.12/€?

Total Revenue= 35000*85000=$2975000000

Option Value=1.085-0.0271=1.0579

$2975000000*1.0579

=3147178125

Gain=3147178125-2656250000=490928125

%=490928125/2656250000

Gain =18.42%

b) the investors consider the U.S. dollar a safe haven currency during the pandemic?

=3147178125-33055555556=158377431

=158377431/3305555556

Loss of 4.79%

2. Assume that the Scenario 2 (Pandemic) took place in 2020 and the euro became a safe haven

currency during the pandemic. What are your euro cash flows if you did not hedge, hedged

using forward contracts, and hedged using option contracts?

1$=0.6826Euro (euro tax heaven look in the table)

Final sales value during pandemic =$1487500000 (17500*85000) Look in the table

0.8929*1487500000=1328188750Euro

refer to excel table Above

DO not hedge=1487500000*0.8929=1328188750Euro

Hedged with forward cover= 1487500000*0.6826=101536750Euri

Option contract= 1487500000-1/(1.085-0.0271) (convert 1.0579$ to Euro 1/1.0579)

=1487500000*0.94527=1406087532Euro.

THe only thing that you have to see is the rate so refer the table as rate has been clearly classified

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