F MAYER IMPORTS HEDGING FOREIGN CURRENCY RISK Pearson

F. MAYER IMPORTS : HEDGING FOREIGN CURRENCY RISK Pearson Deaton Kevin Grant Rafi Goldman Paulina Nowak

Agenda 1. Introduction 2. Company overview 3. EX Risk Hedging Possibilities 4. Conclusion

F. Mayer Imports Private company created in 1957 by Fredrick Mayer Headquarter in Banksmeadow, Australia Import and distribution of high end European food products in Australia

Business Overview Import over 1, 000 top quality products Euro 70 Millions of product procurement annually Assets of the company are in AUD and liabilities in EUR Strong AUD/EUR exchange rate between 0. 700. 80

EX Risk Hedging Practice Vanilla forward contracts – agreement for the future delivery of specific EX at specific date Contract created at the time of the top EX AUD/EUR Duration: 1 -3 months; 30 -40% of exposure has been hedged Often after the hedge EX rose – company losing margins However, at the end of 2013 EX started to be unfavorable: • October 2013 EX AUD/EUR 0. 7027 • January 2014 EX AUD/EUR 0. 6369

Options to Hedge Risk 1. Not to hedge 2. Forward Contract 3. Put and Call Options 4. Collar Options 5. Knock in Forward Options

Hedging EX Risk Budget rate for 2014 - AUD/EUR 0. 6900 Current trade AUD/EUR 0. 6930 Liability: 70, 000 EUR = $101, 010, 101 AUD 1. Not to hedge - If spot rate in 4 months will be higher than the FEC rate 2. Hedge with the 4 months Forward Exchange Contract at rate AUD/EUR 0. 6910 Liability: 70, 000 EUR = $101, 302, 460 AUD

OPTIONS Contract that offers the buyer the right, but not the obligation, to buy (call option) or sell (put option) the underlying asset at an agreed-upon price during a certain period of time Options are between two parties: 1. Holder – Buyer of the contract 2. Writer – Seller of the contract The agreed upon price is called the strike price Premium is the price paid for the option

Put and Call Options Call Option gives the holder the right but not the obligation to buy an underling asset at specific price at a predetermined date Mayer case: Call option is to buy Euro Put Option gives the holder the right to sell an underling asset at a specific price and a pre-determined date Mayer case: Put Option is to sell AUD

Put and Call Options F. Mayer Imports Option 1 Option 2 Liability 70, 000, 000 EUR Strike 1 0. 6910 Strike 1 0. 6860 Converted to AUD $101, 302, 460 AUD Premium of 2. 13% Total AUD $2, 157, 742 AUD $103, 460, 203 AUD Converted to AUD $102, 040, 816 AUD Premium of 1. 81% $1, 846, 939 AUD Total AUD $103, 887, 755 AUD The first option gives a better rate that is 50 PIPS higher but the premium is. 32% higher

Collar Option • Simultaneously writing out-of-money call option and purchasing outof-money put option • Both have same expiration date • Maximum return (Best Case) = strike price of call • Minimum return (Worst Case) = strike price of put • If exchange rate remains between strike price of the call and put, both options expire • Why? • Insurance if exchange rate becomes unfavorable https: //www. investopedia. com/terms/c/collar. asp

Collar Option F. Mayer Imports Expiration Date Value Date B Put Strike S Call Strike Range January 14, 2015 January 16, 2015 0. 6860 $102, 040, 816 AUD 0. 6942 $100, 835, 494 AUD 0. 0082 Expiration Date Value Date B Put Strike S Call Strike Range January 14, 2015 January 16, 2015 0. 6810 $102, 790, 015 AUD 0. 6983 $100, 243, 448 AUD 0. 0173

Knock in Forward Option • A knock-in option is a latent option contract that begins to function as a normal option ("knocks in") only once a certain price level is reached before expiration • Knock-ins are a type of barrier option that are classified as either down-and-in or an up-and-in • A barrier option is a type of contract in which the payoff depends on the underlying security's price and whether it hits a certain price within a specified period https: //www. investopedia. com/terms/k/knock-inoption. asp#ixzz 5 Xv. Oaq. M 4 c

Knock in Forward Option F. Mayer Imports Liability 70, 000 EUR Spot Rate Four Month FEC 0. 6980 $100, 286, 533 AUD 0. 6910 $101, 302, 460 AUD Buy Put Strike Sell Call Strike 0. 6890 $101, 596, 517 $294, 056

Knock in Forward Option F. Mayer Imports With the first part of this solution you have the Buy option to Call(buy) Euro and PUT (sell) AUD at. 6890 which is 20 pips below the four month FEC contract This will cost you an additional $284, 056 AUD but you also have the choice to not exercise the option if the spot rate at the time is better then the option rate The second part of this option is the knock-in forward piece If during the start time and Expiration time that rate increases to. 7140 you are knocked into a sell option to Call (Buy) AUD and PUT (Buy) Euro at the same rate of. 6890

Recommendation: Knock-In Option • For the previous 12 months, the AUD/EUR had been trading well below the 0. 6900 budget range • Collar option locks in to a rate too low if it continues to fall (30 -80 pips below the knock-in rate of 0. 6890) • Not hedging too risky given weak consumer sentiment, falling iron ore price, and subpar economic growth • Want to hedge against depreciating AUD while still leaving some wiggle room for profits if it does appreciate • Still don’t think it will reach the knock-in rate of 0. 7140 • The 20 pips lost relative to the FEC of 0. 6910 (given the liability of $70 M EUR) is far below the premium cost of the put/call options • Willing to take on some risk and forgo the 20 pips (AU$294, 056) relative to the 4 -month FEC in order to capitalize on the potential profits gained if the rate ends up being greater than 0. 6910 and less than 0. 7140