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VOYAGES SOLEIL:The Hedging Decision
Jennifer Gore, Lani Heinemann, Kimberly Kam, Ricky Lai and Nadejda Zaitchenko
Dr. Greco - Finance 570 - April 30, 2009
Agenda
Company & Industry Background The Case Issues Alternatives Recommendation The Outcome Conclusion
The Company
One of Canada’s leading tour operators in packaged vacations to the Caribbean and South America
Headquarters located in Quebec and established in 1975
Jacques Dupuis is the president and owner Built strong relationships with customers to
lend to its leadership status in the industry
The Company (Cont.)
Experienced sales growth of 50% from 1997 to 2001, but experienced 5% decline since 9/11
Forecast for 2002 shows returns to pre-9/11 levels
Majority of clients are from Quebec Most popular destination packages: French
Caribbean, Costa Rica, Cuba, Florida and Mexico
The Canadian Tour Operating Industry
Average growth rate between1998 and 9/11/2001 was greater than 8%
9/11 attack slowed US economy in general, but especially affected the travel industry
Canadian travel to the US fell by 25% after 9/11 Trips to Canada’s largest markets Florida and
Mexico declined by 15% and 12% respectively 30% to 50% decline in overall industry volume 2 of 7 largest tour companies declared
bankruptcy
The Case Clients pay in CAD, but vendors only accept USD
- VS vulnerable to FX risk April 1, 2002 deadline for VS to decide on its FX
risk strategy for US$60 million in payables due October 2002
CAD has been depreciating against the USD since 1998
Canadian GDP reported to be 2.4% in March 2002
Dupuis was faced with uncertainties about the ability to pay vendors if CAD continues to weaken
Market Conditions
Canadian Stock Market Index – (Exhibit 3) experiencing a great deal of volatility in recent years
Canada experiencing large swings in inflation/deflation since 3Q 2001
These are both indicators that the Canadian market is volatile and unpredictable, likely due to more macro-economic factors that are affecting the Canadian economy
Market Conditions
Factors Contributed to CAD to USD Fluctuations
Slower than expected recovery of financial market since the events of 9/11
High-profile corporate scandals US growing deficit United States possibly to go to war in the
Middle East Overall weak economy, with business and
consumer confidence expected to rise in 2002
Opportunities
Canadian economy should grow at a faster rate than the US in the next 1-2 years as CAD was not affected to the same extent by the events of 9/11
Lower interest rates could potentially encourage consumer spending in Canada
VS should look into expanding its packages to European customers
VS should also look into destinations that accept denominations other than USD to minimize their risk exposure
Constraints
Unable to predict real demand for travel packages
Fulfillment of paid travel packages Hedging cost Cash Flow Justify FX Hedging decision to stakeholders
(management, investors, or stockholders)
Timeline
10/02 – 01/03
Basic Issues
Importance
UrgencyLow
Low
High
High
Economic Conditions
Foreign Exchange Risk
Competition
Supplier Relationships
Immediate Issues
Importance
UrgencyLow
Low
High
High Wait or Make a Bet?
Forecasted Demand
Pricing
Products
Cause and Effect
Threat to Short-term Profitability
Decrease in Product Demand
Lack of FX Hedging Strategy
Industry Instability
Economic Slowdown
Assumptions
VS has enough resources to support all alternatives Cash flow Accounting and financing capabilities
10/1/2002 – need $60 million USD available for accounts payables
Using the exchange rate of 0.6000 Every $1 CAD = $0.60 USD
Alternative 1-3 (data from case) Alternative 4 (data from 4/30/09)
Decision Criteria
Determine the best alternative with the following considerations:
Minimize cost Maximize savings Minimize accounting exposure Least amount of currency risk exposure Ease of implementation
Alternatives
1. Wait and use the spot rate at the time payables are due
2. Forward contract 6-month
3. Borrow CAD to purchase USD and invest USD for 6 months
4. Call option to purchase USD with a 6-month expiration
X-rate prediction
At current exchange rate of 0.6298 US$60M payable would cost Cdn$95,268,339.16
Under IFE Canadian dollar is expected to appreciate Under PPP Canadian dollar is expected to depreciate
March 2002 US Canada
Interest rate 4.75% 3.75%
Inflation rate 1.1456% 1.8538%
Method Formula Projected rate
IFE 0.6328
PPP 0.6276
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Alternative 1
Do nothing, exchange Canadian dollars in October
Rate used X-rate Amount (CAD$)
Case 0.6000 $100,000,000.00
IFE 0.6328 $94,816,687.74
PPP 0.6276 $95,602,294.46
Actual Oct. 1, 2002 0.6305 $95,162,569.39
Alternative 2
Forward contract for US$60 million locking in a 6-month forward rate at 0.6271
Regardless of what happens to exchange rates, CAD required = $95,678,520.17
Bank typically requires a 15% to 18% line of credit for this 6-month contract VS would need to use cash as collateral
Alternative 3
Borrow CAD to buy USD on April 1 and invest US dollars for 6 months
Deposit USD with 1.65% interest rate USD needed to deposit is $59,026,069.85
CAD$ at 2.7% interest plus principal= $96,252,419.40
Difficult to explain the interest payment for accounting purposes
Alternative 4
Call option to purchase USD that expires in 6 months
April 30, 2009 rate = 0.8333 Premium cost = USD $2,285,000
3.8% of USD $60,000,000 Assuming 3% money market rate for 2002 3% annual yield = 1.5% for 6 months 3.8% - 1.5% = 2.3% Real Cost
Alternative 4 (Cont.)
Strike Price = 0.8333 Breakeven = 0.8529 CAD needs to appreciate by 2.4% to
breakeven 0.8529 – 0.8333 = 0.0196/0.8333 = 2.4% Using 0.60 rate, CAD would only need to increase
to 0.614 to breakeven Strike Price < Spot Rate = Profit (In-the-money)
Evaluating Alternatives
Do Nothing $95,162,569 Too much risk Unpredictable
Best result on 10/1/02
Forward $95,678,520 Locked in contractNeed LOC
Safe bet with certaintyBetter than #3
Borrowing USD
$96,252,419 Too costly & less savings than #2Accounting
Call Option Unknown Flexible Profitable
Possible best option
Expectations
CAD is considered as a commodity currency closely tied to crude oil More uncertainties
US has engaged war with the Middle East US economy expected to weaken
USD less in demand
Outcome
Recommendation
Forward contract
Need Call Option premium cost on 4/1/02 to determine if Alternative 4 would be better
If making a decision today, Alternative 4 would be the best recommendation
Additional Recommendations
Implement FX risk sharing strategy with suppliers
Set up a multi-currency account to purchase and hold USD
Offer travel packages to Europe and Japan Management should take Dr. Greco’s
FIN 570 class
Conclusion
Currency forecasting has many variables and has certain unpredictable elements
Firms NEED to have FX hedging strategy in placed
Can not only rely on quantitative analysis Always consider micro and macro factors
Questions?