Question

As the new treasurer of Pear Computer. Inc one of your main tasks is to manage the company’s foreign exchange activities. The company has recently launched a new product in Europe and is expecting to generate significant revenues over the next 12 months pear computer already has other activities in Europe including manufacturing facilities where it has a significant number of employees etc.

Pear Computer is expecting to generate €10 million in revenues this year and due to its manufacturing activities in Europe. The company will also incur € 8 million of expenses. There are no other revenues or expenses for pear computers in Europe.

1. What is Pear Computer’s net exposure to euros this year? And are they LONG or SHORT Euros

2. Pear computer's need to fund it operations In Japan at the end of the year and would like to use any surplus funds from Europe for this activity. Assume that today is January 1st and the company's year-end is December 31st. Using the following market rate what transactions would Pear computer execute in order to hedge its foreign exchange risk at the end of the year and calculate the expected amount of Yen that Pear computer’s Japanese operations Should receive at year-end (ignore transaction cost)

Spot	3- Month Forward	6- Month Forward	12 -Month Forward
C$1.2410- 30 / €	C$1.2450- 80 / €	C$1.2510- 30 / €	1.2550- 80 / €
¥110.20- 30 / C$	¥ 111.40- 50 / C$	¥111.70- 80 / C$	¥112.10- 20 / C$

As the new treasurer of Pear Computer. Inc one of your main tasks is to manage the company’s foreign exchange activities. The company has recently launched a new product in Europe and is expecting to generate significant revenues over the next 12 months pear computer already has other activities in Europe including manufacturing facilities where it has a significant number of employees etc. Pear Computer is expecting to generate €10 million in revenues this year and due to its manufacturing activities in Europe. The company will also incur € 8 million of expenses. There are no other revenues or expenses for pear computers in Europe. A) What is Pear Computer’s net exposure to euros this year? And are they LONG or SHORT Euros B) Pear computer's need to fund it operations In Japan at the end of the year and would like to use any surplus funds from Europe for this activity. Assume that today is January 1st and the company's year-end is December 31st. Using the following market rate what transactions would Pear computer execute in order to hedge its foreign exchange risk at the end of the year and calculate the expected amount of Yen that Pear computer’s Japanese operations Should receive at year-end (ignore transaction cost) Spot 3- Month Forward 6- Month Forward 12 -Month Forward C$1.2410- 30 / € C$1.2450- 80 / € C$1.2510- 30 / € 1.2550- 80 / € ¥110.20- 30 / C$ ¥ 111.40- 50 / C$ ¥111.70- 80 / C$ ¥112.10- 20 / C$

Answer 1

Pear has a revenue of Euro 10 Mn and expenditure of Euro 8 Mn. Hence, the company has a net profit of Euro 2 Mn from its European operations. Hence, the company is expecting to receive an amount of Euro 2 Mn at the of the financial year through repatriation. This implies that the company is net long in Euro exposure.

The appropriate hedge exposure will be to enter into a forward contract to sell Euro exposure at a forward contract price. The company wishes to fund its Japanese operations through the European profits. Hence, it needs to purchase Yen and sell Euro at the end of the year. Pear should enter into a 12-month forward contract to sell Euro and buy Yen.

We have been given cross currency exchange rates between Yen, Canadian $ and Euro. We can get the Euro-Yen exchange rate as follows-

Selling price of Euro to Canadian $ * buying price of Yen from Canadian $

Simplified-

We will receive 1.2550 Cad $ for every Euro and 112. 10 Yen for every Cad $ as per the 12-month forward contract. the currency in the denominator in both the rates is the base currency. Since we are purchasing the pricing currency in both the cases (Euro to Cad $ and Cad $ to Yen), the bid rate will be applicable for us in both cases. An easier way to remember this is – the rates are quoted such that the purchaser i.e. the company will receive less foreign currency for every base (domestic) currency i.e. the lower rate from the quote but will have to pay higher amount to purchase the base currency by selling the foreign currency i.e. the higher rate from the quote. The difference between the two rates is the margin of the broker.

12-months forward exchange rates-

Cad $ 1.2550 / € * ¥112.10 / Cad $ = ¥ 140.6855 / €

The net amount received at the end of 12 months by entering into this contract is-

140.6855 * 2,000,000 = ¥ 281,371,000