In: Finance
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?