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1. quantify each of the different utility(a)s. Justify your assumptions and argue which is the outstrip one for Dozier. after their bid was accepted, Dozier has three elections to choose from. Of the three choices, the 1st alternative yields the just about profit. However, the profit from alternative 1 arousenot be guaranteed, and it is much more volatile. The follow wants to expand its commercialize to the U. K. and in any case guarantee the profit ( term minimizing substitute hazard). Therefore, alternative 2, which has a higher profit margin than alternative 3 is the best hedging choice for Dozier. Alternative 1Alternative 2 Alternative 3 dollar frugal value of the balance $1,505,086. 88 $ 1,501,438. 5 $1,493,995. 00 Dollar value of the catch $1,677,311. 33 $1,673,663. 00 $1,666,219. 73 Total price $1,642,783. 00 $1,642,783. 00 $1,642,783. 00 Profit $34,528. 32 $30880 $ 23,437. 00 shargon of Profit 2. 10% 1. 88% 1. 43% appeal of Hedge N/A -1. 20% -1. 70% The detai led calculation is shown below. Alternative 1 Do Nothing Dozier would choose to remain unhedged, and expose itself to funds adventure. We tole ordinate the go with will supervene upon the 10% deposit into dollars and deposit into the U. S. anks directly. The follow can obtain sp be-time activity revenue from this part of deposit. The home outwit rate in U. S. dollars on January 14 is 1. 437. The company can claim ? 117,500 ? 1. 437 = $168847. 5 when they exchange the deposit. Three-month deposits occupy rate in the U. S. is 8% annually. Therefore, the interest rate would be 0. 08/4=2%. The company can hurt $168847. 5 ? 1. 02 = $172224. 5 from the 10% deposit. The company will receive GBP 1. 0575 jillion on April 14,1986. The exchange rate on April 14 remains unknown. However, the drum has weakened over the previous six weeks.CFO, Rothschild was also concerned that the value of the crash readiness depreciate even further during the next 90 days. We can set three possi ble range with different possibilities. harmonize to Exhibit 5, the 3-month onwards rate is 1. 4198. This is the scenario that has the highest probability of occurring in the future because it is the intimately reasonable manage rate on April 14. This is the base pillowcase from which to tax the other two alternatives. We can also run the regression (see appendix, chart 1) on the recent eight weeks and achieve the exchange rate on April 14, as the worst case.Another regression can be run base on the half year exchange rate (see appendix, graph 2). This case can be set as the best one which shows unyielding term data. Receivables Exchange Rate tax income Probability Base show window ?1,057,500 1. 4198 $ 1,501,438. 50 50% Worst Case ?1,057,500 1. 3617 $1,439,997. 75 25% outperform Case ?1,057,500 1. 4917 $1,577,472. 75 25% The positive expected revenue from receivables would be Base Case Revenue ? Probability + Worst Case Revenue ? Probability + Best Case Revenue ? Proba bility = 1,505,086. 88. Therefore, Revenue from Receivables $ 1,505,086. 88 Revenue from Deposit $172224. 45Total Expected Revenue $ 1,677,311. 33 Total Cost $1,642,783. 00 Profit $34,528. 32 Percentage of Profit 2. 10% We can also perform break-even analysis here. The exchange rate would be 1. 3906 when the profit is zero. Therefore, if the horn in depreciate to 1. 3906, the company would suffer a loss for this contract. Alternative 2 If Dozier sells spanks send 90 days Dozier would incur an obligation to deliver pounds 90 days from 1/14/86 at the rate of 1. 437. This would meet that Dozier would receive a certain amount of money, regardless the change of exchange rate. The 3-Month Forward Rate in U. S.Dollars on 1/14/86 is 1. 4198 and the balance is GBP 1. 0575 million. thence, Dozier would receive 1. 4198 ? ?1. 0575 million = $1501438. 5 after three months. As we discuss above, the company can get 168847. 5 ? 1. 02 = $172224. 5 dollars from the 10% deposit. Therefore, the a ctual revenue of the contract is 1501439 + 172224. 5 =$1673663. The total cost is $1642783. Thus the profit is 1673663 1642783 = $30880. The percent of profit is 30880/1642783 = 1. 88% If the rate remains the alike as 1. 437, the rest pounds has the value of 1. 437 ? ?1. 0575 =1519627. 5 million. The cost of hedge is (1501438. 5 1519627. )/1519627. 5 = -1. 2% Alternative 3 If Dozier secures a 90-day pound bring Dozier can also do a spot hedge, which worked similarly in that it also created a pound obligation 90 days. Dozier would borrow pounds from posit and exchange the proceeds into dollars at the spot rate of 1. 4198. Dozier would use its pound receipts, ? 1. 0575 million, to repay the impart. The rate of loan would be at 1. 5% above the U. K. prime rate. Since the loan rate for three months is (1. 5% + 13. 5%)/4=3. 75%, Dozier could receive ? 1. 0575 million/ (1+3. 75%) = ? 1019277 on 1/14/86. Then he would exchange them to dollars.With the spot transaction at 1/14/86, Doz ier would get ? 1019277 ? 1. 437 =$ 1464701. 2 on 1/14/86. To get more profit, Dozier would deposit dollars. At end of three months, they would receive $ 1464701. 2 ? (1+8%/4) = $1493995 for ? 1. 0575 million. As we discuss above, the company can get 168847. 5 ? 1. 02 = $172224. 5 dollars from the 10% deposit. Thus, the actual revenue of the contract is 1493995 + 172224. 5 =$1666219. 73. The total cost is $1642783. Ergo the profit is 1666219. 73 1642783 =$ 23437. The percent of profit is 23437/1642783 = 1. 43%. The cost of hedge is (1493995 1519627. 5 )/1519627. = -1. 7% 2. What is the relation surrounded by the forward rate,the spot rate and the interest rates in the US and the UK? below atomic number 18 the formulas from the suggested reading. It can show the consanguinity between the forward rate,the spot rate and the interest rates. Forward rate in U. S. Forward rate in U. K. If we divide forward rate in U. S. by forward rate in U. K. , we can get formula below Generally , the relationship between silver spot rates and futures rates are ground on interest rate parity, in which the exchange rate is located by the relative interest rates, and the expected future spot rate.From the formulas above, we can see that if the US risk-free rate is less than the British pound rate, the futures exchange rate will be less than the current spot exchange rate. Relative to the spot rate, the forward rate tells you whether interest rates in one currency are higher or put down than those in the other currency. The worldwide Fisher effect suggests the currency of the awkward with the higher nominated interest rate is expected to depreciate against the currency of the country with the lower nominal interest rate, as higher nominal interest rates reflect an expectation of inflation. 3.Are on that point alternative ways for Dozier to value itself from currency risk? Yes. There are five alternatives for Dozier to protect itself from currency risk. First, Dozier could offset the pound exchange risk by hedging with options. Calls would be used if the risk is an upward trend in price, while puts are used if the risk is a downward trend. If the risk was a depreciation of the pound, Dozier would need to buy put options on pounds. If pounds were to depreciate at the time Dozier receives its pound revenue, then Dozier would exercise its right and thereby effectively obtain a higher exchange rate.However, if the pound was to appreciate instead, Dozier would then let the contract expire and exchange its pounds in the spot market at the higher exchange rate. The options market allows traders to experience un check kind movements while limiting losses. This feature is unique to options, unlike the forward or futures contracts where the trader has to forego favorable currency rate movements, plus there are also no limits to losses. The advantages of options over forwards and futures are the limited downside risk and the flexibility and variety of st rategies made possible.Also, in options there is uncomplete the initial margin nor the daily variation margin since the position is not marked to market. This relieves traders from potential cash flow problems. Options are however, more dear(predicate) because they are much more waxy compared to forwards or futures. The option price is therefore its disadvantage. Another alternative for Dozier to protect itself from currency risk would be to use profit generated in British pounds to buy fixed goods which are then sold in the US in dollars. For example, British beer.Presumably, the beer industry has a low beta since most people are going to drink, regardless of economic standings. There whitethorn even be a tendency for people to drink more during hard economic times. If Dozier were to purchase British beer in pounds, the value would be retained when resold in the US, thus protecting the firm from exchange risk. The primary cost associated with this may be tariffs and other tax es on imports to the U. S. Third, similar to the alternative above, Dozier could direct profits earned in British pounds into other U.K. investments. From the case, it is believed that the company wants to continue its international growth. The company can use the profits earned to expand the abroad market. Holding a large portfolio of international units can in the gigantic run, reduce unsystematic risk isolated in the U. S. Fourth, because the pound might depreciate further during the next 90 days, Dozier can accelerate the mop up of the project to offset currency risk (predicted depreciation of the pound) by roll up payment prior to the agreed upon date.Finally, the company can benefit from currency swap. It is a alien-exchange agreement between two institutions to exchange aspects of a loan in one currency for equivalent aspects of an equal in take in present value loan in another currency. Currency swaps are motivated by comparative advantage. For instance, if Dozier nee ded to acquire pounds and a U. K. company needed to acquire dollars, these two parties could arrange to swap currencies by establishing an interest rate, an agreed upon amount, and a maturity date.These currency swaps are negotiable for at least 10 years making them a very flexible method of foreign exchange. Additionally, since swaps are considered a foreign exchange transaction, they are not required to be listed on a firms balance sheet. 4. Should Dozier diversify its currency risk? Does it have a comparative advantage in be unhedged? Yes, controlling the currency risk is an of the essence(p) instrument for controlling and improving performance of international investments. In remaining unhedged Dozier may not necessarily have an advantage.While option 1 was reckon to be the most profitable, this depends on the exchange rates remaining relatively high. The exchange rates will fluctuate. The value of the dollar could increase or the pound could decrease leading to losses. If i t goes below 1. 3906, the company would suffer a loss. It is the first time that Dozier is expanding into a foreign country. For Dozier to continue to expand into foreign markets, it is essential that cash flows are generated. Hedging offers Dozier exchange rate risk protection in the vent the value of the British pound falls. It would refuse the risk and guarantee the necessary cash flows. For the same reasons however, it may be Doziers best interest to remain unhedged. If they already planned for a 6% profit margin, exposing themselves to more risk may be the except way to get a this return. A riskier, unhedged position may be further incentivised by a principal agent problem between Rothschild and the CEO. It is not explicitly stated, but as the CFO, Rothschilds job may be on the line if he does not perform.Therefore, the added risk in order to cover for past 6 weeks exchange losses may be his last hope. It will not cost him any more to take on the additional risk if he is alre ady facing a high probability of losing his job. Agency cost aside, the question boils down to this Is a high probability of a downcast profit better than a small probability of a broad profit. Considering this is their first international project, it might be best to go with what is certain, fetching small steps, and learn from their mistakes going forward into future projects. Appendix chart 1 Graph 2