In July 2014, crude oil price averaged at US$105 per barrel. As of March 2016, crude oil price have plummeted to about US$36 per barrel throwing the economies of many oil exporting countries into disarray. Large oil producing companies have likewise faced various financial and budgetary constraints as a result of the tumultuous changes in global oil prices.
As a manufacturer of oil and petroleum-based products in Malaysia, Two Brothers Berhad, faces a disproportionate amount of uncertainty, at least over their next fiscal period. This is particularly so since on Monday, 7th March 2016, they signed an agreement with a U.S.-based oil-producing company to purchase 1 million barrels of oil per year for the next five years. The sales price of the first 1 million barrels has been agreed at USD36.00 per barrel with payment due in six months. The MYR/USD exchange rate on 7th March 2016 was 4.0545 – 4.0690/ USD. The price per barrel of the next four shipments of 1 million barrels per year will be negotiated before 31 January of each subsequent year and will be highly dependent on world crude oil prices at the time of negotiation.
As the financial controller of Two Brothers Bhd., how can the company manage its foreign exchange risk exposure over the next fiscal period for the above transaction. Through your contacts in the Malaysian financial market, you have managed to obtain the following information:
i) Six-month forward rate for MYR/USD is 4.42 - 4.45
ii) Six-month investing/borrowing interest rates in Kuala Lumpur are 4.00 / 6.00 % per annum
iii) Six-month investing/borrowing interest rates in U.S. are 3.00 / 4.00 % per annum
Due to financial regulatory restrictions in Malaysia, currency options are not available. The closest liberalized foreign exchange market is Singapore that has provided the following:
i) Six-month put option on USD is priced SGD0.02/USD at a strike of SGD1.75/USD
ii) Six-month call option on USD is priced SGD0.03/USD at a strike of SGD1.75/USD
iii) Six-month forward rate for MYR/SGD is 3.04 – 3.08.
iv) The spot rate for MYR/SGD is 2.94 – 2.97.
a) Given the above information, what is your recommendation to the Board of Directors of Two Brothers Bhd., and why? (please ellaborate in full details)