Case 37 Baker

Case Study 37, Baker Adhesives

Baker Adhesives was a modest adhesives company founded by Doug Baker’s father who was a chemist and believed in flexible production systems. Baker Adhesives recently sold 1,210 gallons of product to Brazilian company, Novo. Initially, this was thought to be a good idea for Baker Adhesives financially; however after factoring in exchange rates, this may not have been the case. In the original order, Novo was charged 104,338.30 BRL for their purchase. After the exchange of currency from BRL to U.S. dollars, Baker Adhesive was estimated to receive $48,371.24 (104,338.30 * .4636). This means that Baker Adhesive brought in $55,967.06 less from their deal with Novo than was expected. Since the exchange-rate risk was not researched, Baker Adhesive brought in less initially projected from their deal with Novo and after subtracting their total cost from what they brought in, Baker Adhesive only made a $3,871.20 profit on the deal. To manage the exchange-rate risk of their deal with Novo, Baker Adhesive could have hedged in the forward market or hedged in the money market. In order to hedge in the forward market, Baker Adhesive would have to make a deal in which the bank would provide Baker Adhesive a guaranteed exchange rate for the future exchange of currencies (forward rate). These contracts specified a date, an amount to be exchanged, and a rate. Any bank fee would be built into the rate. By securing a forward rate for the date of a foreign-currency-denominated cash flow, Baker Adhesive could eliminate any risk due to currency fluctuation. For Baker Adhesive, this meant that the anticipated future inflow of real from the sale to Novo could be converted at a rate that would be known today. Hedging in the money markets on the other hand, would allow Baker Adhesive to make any currency exchanges at the known current spot rate. To do this, Baker Adhesive would need to convert future expected cash flows into current cash flows. This...