Case Study A
Introduction:
Dozier Industries is an organization involved in the business of developing electrical security system that helps in providing security. During 1966, it started to focus on developing the system for military operations in Vietnam however; soon the US involvement in the country reduced due to which the demand for the organizational product also decreased in relation to it, consequently the organization decided to focus on private sales. During 1993, it launched a marketing effort for intriguing demand from overseas location about its product offerings and as a result of its success; it is able to secure a contract from one of the manufacturing firm in the United Kingdom.
dozier industries b case solution
Analysis:
Exchange rate exposure and Profit and loss changed over the day:
The organization placed a bid in order to secure a contract from the manufacturing firm in UK, which decided to pay the total amount of 594,000 pound for the installation of internal security system. As a result of the contract, it receives the amount of 59,400 pound in advance and the remaining amount of 534,600 pound is yet to be received in 90 days.
Due to the time lag between the transaction date and the date at which the remaining amount would be received, there is a high probability for the organization to get exposed to a foreign currency risk, where it could receive less money in dollars (its functional currency) due to the depreciation of pound. As shown in Appendices, if the exchange rate between pound and dollar reduces from 1.4480 to 1.41, then it could give a loss of $ 20,315 due to depreciation of pound.
Hence, this shows that Rothschild has lost.
As it’s a fact that the rate decreases from 1.45 to 1.41, due to which the profit and loss of the contract has also changed over the day from $ 774,101 to $ 753,786.
Expected Future Spot rate:
The Expected future spot rate between Pound and Dollar could be calculated by applying an interest rate parity relation between the two currencies. This interest rate differential will reflect the change in exchange rate between the two currencies. Based on the appendices, the expected future spot rate would be $ 1.37 from the current spot rate of $ 1.41.
Hedging Options:
In order to hedge against the risk, the organization could hedge using the following techniques:
- It could use a forward contract, which would fix it to receive the dollar at a fixed rate of $ 1.4118; this means that the organization would be insulated from any depreciation in currency. This option would receive the total amount of $ 754,748.......
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