Jumping jackasses! Not another one! groaned George Luger. It was a memo from the CEO of DVR

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"Jumping jackasses! Not another one!" groaned George Luger. It was a memo from the CEO of DVR Importers dated December 31, 2007. It was the third memo from the CEO that he had received that day. It read as follows:

From: CEO's Office

To: Company Treasurer

George,

I have been looking at some of our foreign exchange deals and they don't seem to make sense. First, we have been buying yen forward to cover the cost of our imports. You have explained that this insures us against the risk that the dollar may depreciate over the next year, but it is incredibly expensive insurance. Each dollar buys only 108.173 yen when we buy forward, compared with the current spot rate of 111.715 yen to the dollar. We could save a fortune by buying yen as and when we need them rather than buying them forward.

Another possibility has occurred to me. If we are worried that the dollar may depreciate (or do I mean "appreciate"?), why don't we buy yen at the low spot rate of ¥111.715 to the dollar and then put them on deposit until we have to pay for the DVRs? That way we can make sure that we get a good rate for our yen.

I am also worried that we are missing out on some cheap financing. We are paying about 6% to borrow dollars for one year, but Ben Hur was telling me at lunch that we could get a one-year yen loan for about 2%. I find that a bit surprising, but if that's the case, why don't we repay our dollar loans and borrow yen instead?

Perhaps we could discuss these ideas at next Wednesday's meeting. I would be interested in your views on the matter.

Jill Edison

How should George respond to Jill's memo? For example,

a. Is the forward purchase of the yen "incredibly expensive insurance?"

b. Would the company be better if it purchased yen and "then put them on deposit?"

c. Should the company "repay its dollar loans and borrow yen instead?"

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Related Book For  book-img-for-question

Fundamentals of Corporate Finance

ISBN: 978-0078034640

7th edition

Authors: Richard Brealey, Stewart Myers, Alan Marcus

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