In the Video on Financial and Operational Hedging, we worked with the following example. Assume you operate plants in two locations: US and Europe, and you face demand in the US and Europe. Both plants have flexible capacity (that is each plant is capable of satisfying demand for both markets) of 150 units. Unit sales price is 20 € ($) in Europe (U.S.). Unit cost is 10 € ($) in Europe (U.S.). Assume 0 transportation/tax/tariff cost. The demand and exchange rate are both random and we assume a simple discrete distribution with only two possible scenarios: Scenario A B Demand in U.S. Demand in Europe Exchange Rate 100 50 $1/€ 50 100 $2/€ Consider 4 possible scenarios: Case 1: Natural hedge (i.e. produce and sell locally); Case 2: Natural hedge + Financial hedge (sell 500 future euros for $1.50 per euro); Case 3: Flexible allocation (i.e. produce in the U.S. when Euro is expensive); Case 4: Flexible allocation + Financial hedge (sell 500 future euros for $1.50 per euro). We solved the first two cases in the video. Find the average profit and profit range for the remaining cases. Compare the results of 4 cases. Comment on the comparison: what is the difference between operational hedging (e.g. flexible allocation) and financial hedging? How do they complement or substitute each other? What managerial guideline can you provide regarding how and when to use operational and/or financial hedging?
In the Video on Financial and Operational Hedging, we worked with the following example. Assume you operate plants in two locations: US and Europe, and you face demand in the US and Europe. Both plants have flexible capacity (that is each plant is capable of satisfying demand for both markets) of 150 units. Unit sales price is 20 € ($) in Europe (U.S.). Unit cost is 10 € ($) in Europe (U.S.). Assume 0 transportation/tax/tariff cost. The demand and exchange rate are both random and we assume a simple discrete distribution with only two possible scenarios: Scenario A B Demand in U.S. Demand in Europe Exchange Rate 100 50 $1/€ 50 100 $2/€ Consider 4 possible scenarios: Case 1: Natural hedge (i.e. produce and sell locally); Case 2: Natural hedge + Financial hedge (sell 500 future euros for $1.50 per euro); Case 3: Flexible allocation (i.e. produce in the U.S. when Euro is expensive); Case 4: Flexible allocation + Financial hedge (sell 500 future euros for $1.50 per euro). We solved the first two cases in the video. Find the average profit and profit range for the remaining cases. Compare the results of 4 cases. Comment on the comparison: what is the difference between operational hedging (e.g. flexible allocation) and financial hedging? How do they complement or substitute each other? What managerial guideline can you provide regarding how and when to use operational and/or financial hedging?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:In the Video on Financial and Operational Hedging, we worked with the following example. Assume you
operate plants in two locations: US and Europe, and you face demand in the US and Europe. Both plants have
flexible capacity (that is each plant is capable of satisfying demand for both markets) of 150 units. Unit sales
price is 20 € ($) in Europe (U.S.). Unit cost is 10 € ($) in Europe (U.S.). Assume 0 transportation/tax/tariff cost.
The demand and exchange rate are both random and we assume a simple discrete distribution with only two
possible scenarios:
Scenario
A
B
Demand in U.S.
Demand in Europe
Exchange Rate
100
50
$1/€
50
100
$2/€
Consider 4 possible scenarios:
Case 1: Natural hedge (i.e. produce and sell locally);
Case 2: Natural hedge + Financial hedge (sell 500 future euros for $1.50 per euro);
Case 3: Flexible allocation (i.e. produce in the U.S. when Euro is expensive);
Case 4: Flexible allocation + Financial hedge (sell 500 future euros for $1.50 per euro).
We solved the first two cases in the video. Find the average profit and profit range for the remaining cases.
Compare the results of 4 cases. Comment on the comparison: what is the difference between operational
hedging (e.g. flexible allocation) and financial hedging? How do they complement or substitute each other?
What managerial guideline can you provide regarding how and when to use operational and/or financial
hedging?
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