Assignment -
(1) Write at least 2 pages
(2) Master degree of Finance level
(3) Topic area: International Finance
EUROPEAN VACATIONS Co.
This (fictitious) Shenzhen tour operator has booked hotel space for the upcoming Christmas Holiday season in Europe, finalizing the contract for Euro 60 million on April 1st, payable October 1st.
The unusually high uncertainty, generated by the BREXIT negotiations, as well as the new German situation and future Italian election, extends to the exchange rate for the Euro.
Therefore it becomes important to protect the expected RMB margin that results from the fact that winter-catalogues with prices in RMB are printed during the summer and Christmas-package tours are marketed during the late summer and early fall. Thus revenue flows occur in September and October.
The government budget deficits in some European countries and the sluggish growth in the southern part of the EU suggest a fall of the Euro, but there is also the potential for the Euro to strengthen due to good growth in Germany and France that may prompt switches from $ to Euro and make the Euro more expensive, also in RMB terms.
On April 1st the issue is whether to hedge the payable (and how) or to wait and see. If the team charged with managing this exchange risk exposure decides to observe how the exchange rate develops, a favourable exchange rate change would enable the company to grant discounts, hence obtain a competitive advantage over competing Chinese tour operators, resulting in stronger demand and bookings. And if, on the other hand, hedging were chosen on April 1st, it could be done by a forward contract or a money market hedge (borrowing in one, lending/investing in another currency).
Your team of participants in the MFM 6 program will prepare a brief overview report on what action should be taken by the company regarding this payable.
The following data is available on April 1st:
Spot RMB trade at RMB/Euro 8.6200 (bid), 8.6300 (ask)
6-months forward Euro trade at RMB/Euro 8.5900 (bid), 8.6080 (ask)
RMB can be borrowed for 6 months at 3.50% p.a.
RMB deposit rates at ICBC (your bank) for 6 month-deposits are 2.50% p.a.
Euro can be borrowed for 6 months at 1.80% p.a.
Euro deposit rates for 6-month deposits are 1.25% p.a.
Total words: 600.