Questions:
1) For the exchange rate of EUR/USD, where estimates are not available, create an estimate by using the daily closing values of the exchange rate from the last 24 months. Argue which period might be most relevant, if you decide to use less than the full 24-month period to create your estimate. Assume that the exchange rate is normally distributed, calculate the mean and the standard deviation, and use these to fill in the values for France in the table of orders.
2) Specify the distribution and report the mean and the standard deviation of total revenue in $.
3) a) What is the probability that this revenue will exceed $ 2,280,000?
b) What is the probability that this revenue will be less than $ 2,160,000?
4) HSBC offers to pay a certain sum of $2,150,000, in return for the uncertain revenue in local currencies. Give an opinion as to whether this is a good offer for USASuperCars or not?
5) In USA SuperCars, the Sales manager is willing to accept HSBC’s offer, but the CEO is not.
Who is more risk-averse?
6) What other risks is the bank taking, apart from the uncertainty in the exchange rates?
7) If the offer is to pay the certain sum next week rather than on New Year’s Day, would that make any difference? When would the bank and when the company would prefer the payment to be made, and why?
8) USASuperCars has accepted HSBC’s offer. Assuming the bank will convert all currencies into US dollars at the prevailing exchange rates. What is the probability that the bank will incur a loss?
9) The bank defines its Value-at-Risk as the loss that occurs at the 5th percentile of the uncertain revenue (5% left tail of the distribution). What is the bank’s Value-at-Risk and what is the banks expected profit?
10) What other options does the bank has if they decide not to convert all/some of the currencies in New Year’s Day?
Executive Summary
The exchange rates that are prevailing in the market determine the level of activities in any trading environment. International business investment decisions take account of exchange risks whenever critical decisions are made. USASuperCars Company is an automaker that is based in the USA and it trades in luxurious sports utility vehicles that are purposely developed for their speed and high acceleration system per kilometer. USASuperCars won a contract to sell several luxury vehicles across the world. The company signed a contract that would allow the Company to receive payments in foreign currencies of the respective countries in year’s time. This report aims to present several scenarios that the USASuperCars may find its revenues in a year’s time. The company also intends to analyze a forfeiting offer that it received from HSBC comprehensively. USASuperCars expects total revenue of $2,202, 685.30 in a high currency exchange risk environment. HSBC is prepared to offer $2,150,000 to USASuperCars that it considers being secured and by accepting the banks offer, USASuperCars minimizes several risks such as political, economical, legal and credit risks. Legal risks may involve the legal expenses that may be incurred when pursuing defaulters or other collection costs. The final part of the paper presents techniques HSBC may utilize to ensure recovery of all the amounts outstanding.
Introduction
USASuperCars is a US based automaker that deals in luxurious vehicle that are exported to foreign markets and their payments made in foreign currencies. The company signed a multimillion contract to supply 27 top of the range sports utility vehicles to various clients across Japan, UK, South Africa, USA and Canada. This kind of international contract is mostly affected by fluctuation of exchange risks as the trading currency is not American dollars hence there is a high chance of volatilization of its revenues.
Relying on the data that was presented by the Bank of America, this report estimates the amount of revenue that the deal would probably achieve from the signed deal as well as stating the opinion on the assessment of USASuperCars forfeiting deals that HSBC has offered. The report also provides the risks that the bank exposes itself by extending the offer the offer to USASuperCars.
The Contract Agreement
Under the contract USASuperCars would supply 27 luxurious vehicles to a number of clients based in different countries. The contract specified the customer’s country of origin, the quantity of vehicles ordered and the selling price per piece. The table below shows the details as provided for in the contract.
Table 1
| Customer | QTY | SP | EX Rate | Deviation |
| UK | 10 | 57,500.00 | 1.408 | 0.041 |
| France | 2 | 65,000.00 | 1.104 | 0.018 |
| Japan 1 | 5 | 8,400,000.00 | 0.00911 | 0.00045 |
| Japan 2 | 3 | 9,000,000.00 | 0.00911 | 0.00045 |
| Canada 1 | 2 | 97,000.00 | 0.82487 | 0.0342 |
| Canada 2 | 2 | 100,000.00 | 0.82487 | 0.0342 |
| S.Africa | 2 | 4,100,000.00 | 0.0211 | 0.00083 |
| USA | 1 | 100,000.00 | 1 | 0 |
The contract also provides that all sales are payable on foreign currencies and payments would be made after twelve months. The company is planning to convert the revenues to American dollars immediately they receive the payments.
USASuperCars considers the transaction as very risky and the fluctuation rates may wipe out their entire profit margins.
Revenue and its Probabilities
The exchange rate makes the amounts payable to USASuperCars as sales revenues to be uncertain. This report discusses some of the most likely scenarios and the amounts that USASuperCars may most likely receive after converting the sales to dollars after 12 months. The figures are derived from the targeted currencies and the historical information that also entails the use of exchange rates deviations from the expected future rates.
Table 2
| Customer | Currency Deviation | |
| Pound | UK | 0.041 |
| Yen | Japan | 0.00045 |
| Yen | Japan | 0.00045 |
| CAD | Canada | 0.0342 |
| CAD | Canada | 0.0342 |
| Rand | S. Africa | 0.00083 |
| USD | USA | 0 |
| Euro | France | 1.104 |
The expected total sales from the transaction are $2,202,685.30.
Diagram1
The following are the probabilities of USASuperCars revenues;
The probability that the company would earn more than $2,280,000 in revenues are 49.8% where as the chances that USASuperCars would earn less than $2,280,000 in revenues are 50.2%.
The probability that the company would earn more than $2,150,000 in revenues are 80.51% where as the chances that USASuperCars would earn less than $2,150,000 in revenues are 19.49%.
The probability that the company would earn more than $2,160,000 in revenues are 71.57% where as the chances that USASuperCars would earn less than $2,160,000 in revenues are 28.43%.
Forfaiting Offer
USASuperCars received the offer by HSBC to make payments amounting to $2150, 000 to foreign countries in exchange for the home country currency that is the American dollar a business known as Forfaiting. Forfaiting offers involve banks making payments on all transactions that the trading company requires for a discount at a time when the payment is required.
Payment Timing
If USASuperCars accepts the offer from the bank, then it would be prudent for it to request and receive the amounts payable as soon as possible. But most banks avoid immediate payments so as to benefit from the money before it’s finally paid. Also the company may utilize the money elsewhere like investing it in other profitable investments.
HSBC Position
HSBC has a high chance of benefiting from the whole transaction and it stands to gain more as the probability of receiving less than $2,150,000 is less than 8.3%. However, the bank estimates its value at risk is 11.9% and that it stands to lose 52685.30 as calculated below (Lexicom, n, d).
Table 3
| HSBC’s Value-at-Risk = initial investment – (mean – 0.1283* standard deviation |
| 2,150,000 – (2179981.21 – 0.1283*34689.59) = $(25330.54) |
| HSBC’s expected profit = mean – initial investment = 2179781.21 – 2,150,000 = $29,781.21 |
HSBC Risks
The other possible risks that the bank may face as a result of accepting the USASuperCars are
Exchange rate volatility
The risks associated with the fluctuation of foreign exchange rates affects most companies that trade internationally and with foreign currencies.
Political risks
The risks affecting a country stemming from political instability may also affect the companies that trade in its foreign currency.
Credit risks
These are the risks associated with lending in the market. Some amount lent out as loans may turn out to be bad loans or non performing loans and companies must set provisions to cushion themselves against such kind of risks.
Inflation risks
Inflation affects a country’s purchasing power. When the currency of a country losses value because of inflation then the companies holding the country’s currency also lose value.
Legal and commercial risks
The risks associated with the cases that the company is facing in courts may also be a big challenge as the courts may fine the company with huge sums of money that may not be available immediately hence its operations may be grossly affected. In business losses can be made hence companies must make provisions to cushion the company against such eventualities.
The other risks that the bank is exposed to besides the uncertainty in the exchange rates. There are many economic risks involved in the banking sector. The performance of the bank and its profitability is a factor that has to be considered. Efficient management signals a positive growth trend which raises the share prices of its stock especially if it’s very profitable. The other risk is the economy. If it’s performing well then it would reflect better prospects for the bank but when the economy is not bad then the banking business is also severely affected. The others are inflation risks, political risks, credit risks and legal risks
Conclusion
HSBC would in normal circumstances delay the payments as the bank generates more income from balance by lending it many times its value to other clients a process known as credit creation. The probability that the company would earn more than $2,280,000 in revenues are 21.7% where as the chances that USASuperCars would earn less than $2,280,000 in revenues are 78.3%.
Recommendation
HSBC forfaiting offer to USASuperCars is a great offer and it should be accepted as it is a safe investment. The major advantage of forfaiting offers is that it avails liquidity conveniently and when required hence the offer should be negotiated to allow earlier access to the fund. In case Supercar accepts the offer, then it would be prudent for them to receive the amounts agreed upon immediately the agreement has been made. But most banks avoid immediate payments as the balance of the banking left in the bank facilitates a lot of credit creation. Also receiving some payments in a few months time is better than receiving it after a longer period time value of money makes savings to lose value over time. The value of the dollar today is worth much more tomorrow. If Supercar receives the payment earlier then they will have an opportunity to invest and earn much more from the investment. The company could also utilize the money for other functions like the payment of operational costs.
Appendix
1.
| EUR/USD | |||
| 2013 | July | 1.0615 | 1.0615 |
| Aug | 1.3213 | 1.3213 | |
| Sep | 1.3208 | 1.3208 | |
| Oct | 1.0617 | 1.0617 | |
| Nov | 1.358 | 1.358 | |
| Dec | 1.358 | 1.358 | |
| 2014 | Jan | 1.3745 | 1.3745 |
| Feb | 1.3488 | 1.3488 | |
| Mar | 1.3775 | 1.3775 | |
| Apr | 1.3793 | 1.3793 | |
| May | 1.3871 | 1.3871 | |
| June | 1.3628 | 1.3628 | |
| July | 1.3682 | 1.3682 | |
| Aug | 1.3422 | 1.3422 | |
| Sep | 1.3132 | 1.3132 | |
| Oct | 1.0617 | 1.0617 | |
| Nov | 1.2503 | 1.2503 | |
| Dec | 1.2438 | 1.2438 | |
| 2015 | Jan | 1.2099 | 1.2099 |
| Feb | 1.1337 | 1.1337 | |
| Mar | 1.1171 | 1.1171 | |
| Apr | 1.077 | 1.077 | |
| May | 1.0617 | 1.0617 | |
| June | 1.0923 | 1.0923 | |
| Mean | 1.249267 | ||
| STD | 0.128397 |
Payment Timing
In case Supercar accepts the offer, then it would be prudent for them to receive the amounts agreed upon immediately the agreement has been made. But most banks avoid immediate payments as the balance of the banking left in the bank facilitates a lot of credit creation. Also receiving some payments in a few months time is better than receiving it after a longer period time value of money makes savings to lose value over time. The value of the dollar today is worth much more tomorrow. If Supercar receives the payment earlier then they will have an opportunity to invest and earn much more from the investment. The company could also utilize the money for other functions like the payment of operational costs (U.S Department of Commerce, International Trade Administration, 2007).
On the other hand, HSBC would in normal circumstances delay the payments as the bank generates more income from balance by lending it many times its value to other clients a process known as credit creation (Trading Economics , n, d)
2.
| Customer | QTY | SP | EX Rate | Deviation | |||
| Pound | UK | 12 | 57,500.00 | 1.407 | 0.041 | 970,830.00 | 800,324,100.00 |
| Yen | Japan | 5 | 8,400,000.00 | 0.00911 | 0.00045 | 382,620.00 | 357,210,000.00 |
| Yen | Japan | 3 | 9,000,000.00 | 0.00911 | 0.00045 | 245,970.00 | 147,622,500.00 |
| CAD | Canada | 1 | 97,000.00 | 0.82487 | 0.0342 | 80,012.39 | 11,005,142.76 |
| CAD | Canada | 3 | 100,000.00 | 0.82487 | 0.0342 | 247,461.00 | 105,267,600.00 |
| Rand | S.Africa | 2 | 4,100,000.00 | 0.0211 | 0.00083 | 173,020.00 | 46,321,636.00 |
| USD | USA | 1 | 100,000.00 | 1 | 0 | 100,000.00 | – |
| Total Revenue | 2,202,685.30 | 1,467,750,978.76 | |||||
| Total | Standard deviation = Variance^0.5=1,467,750,978.78^0.5 | 38311.23 |
3. The probability that the company would earn more than $2,280,000 in revenues are 21.7% where as the chances that USASuperCars would earn less than $2,280,000 in revenues are 78.3%.
| Probability that the mean will exceed 2,280,000 | |||
| Prob (x > 2,280,000) = Prob (z > (x-m)/ϭ) = Prob (z > -2.018 | |||
| 2202685.30-2280000/38311.23 | = 21.7% | ||
| Probability that the mean will exceed 2,160,000 | |||
| Prob (x > 2,160,000) = Prob (z > (x-m)/ϭ) = Prob (z > 1.1147) | |||
| 2202685.30-2160000/38311.23 | = 87.49% |
The probability that the company would earn more than $2,150,000 in revenues are 91.62% where as the chances that USASuperCars would earn less than $2,150,000 in revenues are 8.3%.
4. it’s a good offer as the probability of exceeding the amount is 91.62%
| Probability that the mean will exceed 2,150,000 | |||
| Prob (x > 2,150,000) = Prob (z > (x-m)/ϭ) = Prob (z > 1.38) | |||
| 1.375192078 | = 91.62% |
5. The manager is more risk averse as he is aware of the potential risks involved an is willing to take a chance.
6. The other risks that the bank is exposed to besides the uncertainty in the exchange rates. There are many economic risks involved in the banking sector. The performance of the bank and its profitability is a factor that has to be considered. Efficient management signals a positive growth trend which raises the share prices of its stock especially if it’s very profitable. The other risk is the economy. If it’s performing well then it would reflect better prospects for the bank but when the economy is not bad then the banking business is also severely affected. The others are inflation risks, political risks, credit risks and legal risks (Cuthbertson & Nitzsche, 2008).
7. The bank would naturally prefer a later date as the banking industry creates money through credit creation. The money at its disposal is lent out many times before it’s eventually released to the owner. The bank would naturally prefer to make the payments on New Year’s Day.
8. The probability that the bank will make a loss is 11.9%
9.
| HSBC’s Value-at-Risk = initial investment – (mean – 0.1283* standard deviation |
| 2,150,000 – (2,202,685.3 – 0.1283*38311.23) = $47770 |
| HSBC’s expected profit = mean – initial investment = 2,202,685.3 – 2,150,000 = $52685.30 |
10. HSBC can lend money using home currencies and invest them in bonds that are being traded internationally. HSBC can also bank the money in foreign currencies to avoid the risks in exchange rates (HSBC, 2014).
References
Cuthbertson, K. & Nitzsche, D. (2008) Investments. 2nd edition. England: John Wiley & Sons, Ltd.
(Lexicom, n, d)
HSBC (2014)
Trading Economics (n, d)
U.S Department of Commerce, International Trade Administration (2007). Trade Finance Guide: A Quick Reference for U.S. Exporters. Washington: Manufacturing and Services, Office of Finance.
