Diva Shoes

Questions

1. What is Diva’s projected profits for the fiscal year ending September 1995?

15M

2. What factors affect a firm’s exposure to exchange-rate risk? How much exposure to exchange-rate risk does Diva Shoes have in April 1995?

Factors affect a firm’s exposure to exchange-rate risk include transaction exposure, economic exposure, and translation exposure. Transaction exposure is a risk caused by the fluctuations in exchange rates. It arises from transactions such as payments or sales in other currencies other than the domestic one. Translation exposure, also known as accounting exposure, referred to the random changes that result from translation of financial statements. It arises whenever profits, assets or liabilities are translated from the operating country to the parent company at home. Economic exposure is a risk caused by random changes in exchange rates due to political and macroeconomic trends in countries where these multinational firms operate in.

In April 1995, Diva Shoes have $43,625,694 exposed to exchange rate risk.

3. Suppose that Diva chooses to hedge its exposure in yen using the forward contract described in case Appendix A or the currency option described in case Appendix B. Assume that you lock in these contracts at the forward price implied by interest-rate parity for September 1995. Draw the payoffs to the position at maturity for each alternative with the exchange rate defined in USD/JPY × 10,000 units (i.e., the same units as the currency option is quoted).

Long Forward payoff

Call Option Payoff

4. What do you see as the trade-offs between the alternatives?

For the forward option, there is unlimited profit/loss and while with the call option, the call buyer loss is limited to price paid.

5. Do you think Bisno should remain strictly a shoe salesman or do you favor hedging his exposure? If you favor hedging, which alternative would you recommend to him?

Bisno should hedge his transactional exposure...