FINA 6204 Northeastern University Stark Supply Co Case Study

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Read the attached case for Stark supply co and also the Stark Supply Exhibit and answer the questions

Beofre you answer read the following

Stark Supply Co. Case (A): Additional Information

  • You should treat February 15, 2018, as the date when you are performing your analysis and acting on the analysis (hedging or not hedging).
  • If First Mississippi Bank is lending dollars to Stark Supply Co., Stark is borrowing from First Mississippi Bank and must repay the loan in 90 days. The amount borrowed is a present value and the amount repaid is a future value. The future value represents Stark’s dollar cost of the SF 1,000,000 payment if Stark hedges with a spot transaction.
  • Deposits are borrowing on the part of a bank, but lending from the perspective of a customer such as Stark Supply Co.
  • Stark purchased SF 100,000 in the spot market on January 18, 2018 to make the deposit payment required by the cowbell purchase contract.

Answer the following questions (also attached as PDF Document)

Stark Supply Co. Case (A) Questions

  1. What is the dollar cost of the deposit payment made on January 18, 2018? (5 points)
    • Note that this payment is made prior to February. This cost remains unchanged regardless of the Stark’s hedging choice.
  2. There are four parts to this question. Note that the futures price on May 16, 2018 for a June 18, 2018 maturity Swiss Franc futures contract and the spot price on May 16, 2018 for the Swiss Franc are both unknown on February 15, 2018. Suppose the futures price on May 16 for a June 18 contract is $1.02 and the spot price on May 16 is $1.025. What is Stark’s total dollar cost if Stark hedges with a futures contract and the futures price on February 15 for a June 18 contract is $1.09?
    1. Suppose the futures price on May 16 for a June 18 contract is $1.02 and the spot price on May 16 is $1.025. What is Stark’s total dollar cost if Stark hedges with a futures contract and the futures price on February 15 for a June 18 contract is $1.09? (5 points)
      • When you calculate “total dollar cost” include the dollar cost of the deposit payment (calculated in question 1), the profit/loss on the futures contract, and the payment to purchase Swiss Francs in the spot market on May 16. If there is a profit/loss on the futures contact, multiply the profit/loss by -1 when calculating cost since a positive profit would represent a negative cost.
      • As described in the Case, the long futures contract that Stark enters into on February 15 is offset with a short futures contract on May 16. Given marking to market, Stark realizes all profits/losses associated with the long futures contract by May 16 when the contract is offset. Once the contract is offset there are no future profits or losses.
    2. Suppose the futures price on May 16 for a June 18 contract is $1.15 and the spot price on May 16 is $1.148. What is Stark’s total dollar cost if Stark hedges with a futures contract and the futures price on February 15 for a June 18 contract is $1.09? (5 points)
      • When you calculate “total dollar cost” include the dollar cost of the deposit payment (calculated in question 1), the profit/loss on the futures contract, and the payment to purchase Swiss Francs in the spot market on May 16. If there is a profit/loss on the futures contact, multiply the profit/loss by -1 when calculating cost since a positive profit would represent a negative cost.
      • As described in the Case, the long futures contract that Stark enters into on February 15 is offset with a short futures contract on May 16. Given marking to market, Stark realizes all profits/losses associated with the long futures contract by May 16 when the contract is offset. Once the contract is offset there are no future profits or losses.
    3. Briefly explain why your answers to parts A and B are similar but not identical? (5 points)
    4. Recall that Stark had originally assumed a constant exchange rate for the Swiss Franc and therefore, forecasted on December 14, 2017 a profit on the cowbells of approximately $188,900. If Stark breaks-even at a cost of $1,300,000, what is Stark’s profit on the cowbells hedging with a futures contract? Compare profit to the profit Stark had originally forecasted. (5 points)
      • Since Stark breaks-even at a cost of $1,300,000, subtract “total dollar cost” from $1,300,000 to calculate profit on the cowbells.
      • Note that you should provide two answers: one answer corresponds to the assumptions in part A above and the second answer corresponds to part B above.
  3. If Stark uses the forward contract to hedge, what is Stark’s total dollar cost of the cowbell contract? What is Stark’s profit on the cowbell purchase? (10 points)
    • Include in total cost, the cost of the January deposit and the May payment.
  4. If Stark uses the spot transaction (also known as a money market hedge) suggested in the case, how many Swiss Francs does Stark purchase in the spot market on February 15, 2018 and how many dollars does Stark borrow from the bank on February 15, 2018 to pay for the Swiss Francs that Stark purchases? (10 points)
    • Note that the spot rate on May 16 is unknown at the time Stark makes its hedging decision on Feb 15, 2018. Stark’s objective is to not have to trade in the spot market on May 16, 2018. There is no foreign exchange risk if it is unnecessary for Stark to buy or sell Swiss Francs on May 16 at the spot rate.
  5. If Stark uses the spot transaction suggested in the case, what is Stark’s total dollar cost of the cowbell contract? What is Stark’s profit on the cowbell purchase? (10 points)
    • Include in total cost, the cost of the January deposit and the May payment.
    • You will need to calculate Stark’s dollar cash outflow on May 16 (the loan repayment). This is Stark’s dollar cost of the May 16 payment of SF 1,000,000.
  6. Marks has already ruled out hedging with the futures contract, because of the complexity of the hedge. A major concern for Marks is that Hunter Paul would not understand the cash flow with marking to market with a futures contract. Of the remaining two methods of hedging, forward hedge or spot transaction, which of the two would you recommend to Marks? (15 points)
    • You should consider both risk and the total dollar cost of each hedge.
  7. Examine the spot exchange rate data in exhibit 1. Observe that the Swiss Franc appreciated 7.22% from December 14, 2017 to February 15, 2018. If the Swiss Franc follows this same rate of appreciation, this suggests appreciation of approximately 3.55%/month or 11.03% for 90 days. Define 11.03% appreciation as constant appreciation.

    Observe that the greatest appreciation over a 4-week period from August 2017 to February 15, 2018 is 5.04%. If the Swiss Franc follows this same rate of appreciation, this suggests appreciation of approximately 15.89% for 90 days. Define 15.89% appreciation as high appreciation.

    Observe that the greatest depreciation over a 4-week period from August 2017 to February 15, 2018 is 2.98%. If the Swiss Franc follows this same rate of depreciation, this suggests depreciation of approximately 8.68% for 90 days. Define -8.68% appreciation as low appreciation.

    For each of the 3 rates of appreciation (constant, high, low), what is the corresponding future spot rate in 90 days (on May 16, 2018)?

    For each of the 3 forecasted future spot rates, what is Stark’s total dollar cost assuming Stark is unhedged and the actual future spot rate is equal to the forecasted future spot rate? What is Stark’s profit from the cowbells? (15 points)

    • You will calculate 3 forecasted future spot rates for May 16, 3 total dollar costs, and 3 profits. Each answer depends on whether constant, high, or low appreciation.
  8. Assuming your answer to question 7 is a reasonable description of what could occur if Stark remains unhedged, discuss whether you would recommend to Marks a forward hedge, a spot transaction hedge or remaining unhedged. (10 points)
    • You will need to base your recommendation on both risk and total dollar cost, since risk is very different if unhedged compared to hedged.
    • You will need to read the case carefully and provide an argument for your choice based on statements and issues raised in the case.
  9. What should Stark have done on December 14, 2017 when it contracted to purchase cowbells from the Swiss supplier? (5 points)

9 days ago

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