Multinational corp finance
On June 1, Northwind Energy, a wholly owned subsidiary of GE, bought a 12 megawatt compression turbine from Groningen Engineering of the Netherlands for €4,000,000,
payable on September 1. The Northwind purchasing team received this price quote of €4,000,000 on May 1 where the current spot rate was $1.0800/€, which equates to the
U.S. dollar price of $4,320,000.
By the time the purchase was made on June 1, the euro had strengthened to $1.1000/€, so
the purchase was in fact worth €4,000,000 x $1.1000/€ = $4,400,000. Northwind had already lost an extra $80,000 from the unfavorable exchange rate movements. With
this, Northwind’s director of finance now wondered if the firm should hedge against more fluctuation in the exchange rate.
Three approaches were possible:
1) Hedge in the forward market. The three-month forward exchange quote was $1.1060/€.
2) Hedge in the money market. Northwind could borrow U.S. dollars from its U.S. bank at 7.00% per annum. The EU investment rate is 6.00% per annum.
3) Hedge with foreign currency options. September put options were available at strike price of $1.1000/€ for a premium of 3.0% per contract. September call options at
$1.1000/€ could be purchased for a premium of 2.0%.
Discuss if Northwind should hedge its
transaction exposure of EUR 4,000,000. If you recommend that the company should hedge, which of the hedging alternatives would better serve Northwind shareholders?
