Corvette sells luxury sports cars and has just signed a contract to sell some of the cars to various customers around the globe. The selling prices for the cars are fixed and are set at the local currencies of the countries where the cars are being sold. However, there is uncertainty in the exchange rates in different countries. The Bank of America has provided them with estimates of the mean and standard deviation. HSBC has offered to pay a sum of $2,150,000 in return for the revenue in local currencies and the management of Corvette is at a cross road whether to accept the payment or not. The sales manager at Corvette is willing to accept the offer while the CEO is not willing. This report therefore provides an analysis on who is more risk-averse and the implications that this offer can have on the company’s performance. . The bank has two options of either paying the sure sum in three months or spreading it across 12 months. We investigate the implications of both offers and establish which of the two is more suitable for the company.
Corvette is intending to sell its luxury sports cars to various countries across the globe. Currently Corvette has signed a contract with five different customers who have ordered for several cars from the company. Even though the prices are fixed at the current prevailing rates across the countries, this company is faced with a risk as a result of the uncertainties in exchange rates. The offer given by HSBC looks good but can have some major implications to the company due to the uncertainties in exchange rates. Depending on the exchange rates in different countries, a given business enterprise can either make losses or make some gains. Should corvette accept to take up the offer given by HSBC, there are some short term benefits that they are likely to get especially when HSBC pays the sure sum in 3 months. The company will be able to get sufficient revenue to run its operations as opposed to when the offer is paid for a period of 12 months. On the other hand, if Corvette takes up the offer and the exchange rates change in the negative side, the company is likely to encounter huge losses as a result of such development.
Besides if HSBC offers to pay a sure sum of $2,150,000 in return for the revenue in local currencies, it is a good offer for Corvette since the differences in local exchange rates can help them get additional revenue from the undertaking. Once Corvette has obtained the $2,150,000, they do not need to incur additional losses which usually results from exchange rates. Most importers prefer obtaining the local currencies of the countries that they are set to operate in. this will also help in catering for the operational costs without the need to exchange the currency once more to the local currencies to facilitate local transactions. However, depending on the prevailing exchange rates, this value could either depreciate or appreciate depending on several economic parameters. If Corvette can agree to take up the offer they will be able to mitigate some of the risks which usually erupt as a result of uncertainties in exchange rates. They are also assured of confirmed revenue as opposed to a situation whereby they are left to hang in the balance with optimism that their business will earn revenue. This is a sure way of obtaining revenue without depending on the prevailing market conditions.
The CEO is more risk averse as opposed to the sales manager who is more inclined. The CEO understands the risks involved in exchange rates and is opposed to the move since the company is likely to encounter several problems as a result of taking up the offer.
The Sales manager is less risk averse and is ready to take up the risk. The exchange rates in several countries are not stable. Therefore taking up the offer could on the other hand lead to risks if the exchange rates tend to fluctuate. However, when the offer is in a stable international currency, then the company is likely to evade the possibility of courting a disaster. A specific example can be referenced to the recent issues in the Euro-zone whereby the economic situation in Europe led to a sharp depreciation of the Euro. Therefore if the sales manager could have accepted payments in Euros before the crisis with speculation that the value of Euros could rise, then he could have been in for a big surprise after leading the company into making huge losses. Therefore even as the bank attempts to pay the company in local currencies, the management of the company need to be wary of the uncertainties in exchange rates which would lead to huge losses.
Speculation in business is a vice that should be avoided at all costs by financial advisors and managers. In some cases it can lead to huge profits while in others it can also lead to huge losses. It is better for a business to make small profits than expose itself to instances of huge losses. The probability of a business making profits through foreign exchange is limited and companies should not take such risks. This problem therefore presents a situation whereby the Sales Manager is risk reluctant and this can lead to huge losses by the company. The deal looks good but should be approached with a lot of caution.
Speculation and gambling are synonymous. A good business establishment should not rely on such activities for its success. The management should ensure that they minimize their losses and avoid instances of allowing their desires prevail upon the operations of their business. Therefore before the management decides to take up the offer, they need to carry out a thorough market analysis to establish their facts before making a decision. The offer should also not be dismissed entirely since it could as well come with opportunities.
- Corvette agrees to take up the offer.
- They are able to obtain a sure amount of money within a short duration of time.
- When the sure sum is paid in whole the company is likely to be faced with risks in uncertainties of foreign exchange especially if the value of the dollar depreciates.
- The company should invest in other currencies so as to reduce the amount of risks in uncertainties of foreign exchange.
- The company should accept the sum offered but spread across different currencies to act as a form of security to the company’s investment.
HSBC has offered Corvette a sure sum of $2,150,000 in return for the revenue in local currencies. However, there are uncertainties in the exchange rates. This report analyses some other risks that the bank is likely face apart from the risk posed by the uncertainties in the exchange rates. The bank has two options of either paying the sure sum in three months or spreading it across 12 months. We investigate the implications of both offers and establish which of the two is more suitable for the bank. We will also investigate the bank’s risk considering assuming the bank will convert all its currencies into US dollars at the prevailing rates and determine the probability that the bank is likely to make a loss. We will also establish to find out the value at risk for the bank and the bank’s expected profit if the bank defines its value at risk as the loss that occurs at the 5th percentile of the uncertain revenue. Finally we will take an insight overview of the other options that the bank has if they decide not to convert all or some of the currencies in 12 months time.
The risk aversion which is driven by exchange rate uncertainties can have a difference between the foreign and domestic prices of goods. There is need for investors to ensure that they properly mitigate the risks that may come out as a result in the uncertainties in exchange rates. Converting all the currencies in a bank into one currency is very risky and can lead very huge losses for the concerned party. Some currencies are unstable and their values keep on changing with time. Therefore if a person or a business entity converts all their currencies to one currency, and it happens that the currency depreciates, then the bank shall have made huge losses. When HSBC offered to give a sure sum of $2,150,000 to Corvette, they had two options of either paying the money within three months or spreading it across 12 months. Apart from that, the bank is also faced with a problem of experiencing several transactional delays due to conflicts of interests. The sales manager and the CEO of the company are faced with decisional wars and this could in turn lead to uncertainty in its venture. The period to be chosen for clearing the payments can also greatly affect the operations of the bank. If the period is prolonged, the company may demand some interest which would lead to the bank spending more than what they had earlier on anticipated. However, if the period is shortened, the bank will be derived of money in their reserves as they move to settle their debts with the company.
The bank is also taking a risk of venturing in a business agreement which has not been fully established are they are unaware of the market trends. They can decide to issue the offer and then later on incur huge losses as a result of lack of revenues from their target markets. Therefore the bank needs to carry out a thorough market analysis before selecting the decision to take as far as this type of business is concerned.
So evidently, both methods have significant effects for the bank. If the sum is paid in three months instead of 12 months, both the bank and the company will be affected. As one is affected positively, the other one will be affected negatively. The company will be able to obtain all the revenue required within a significantly small duration hence be able to advance their expansion strategies. The bank on the other hand will be depleting its reserves of local currencies hence jeopardizing their operations. This implies that the bank would prefer the payments be cleared within a prolonged period of time so that they can conserve their reserves. The company on the other hand would prefer that the payments be made within the shortest period of time so that they can be able to advance their expansion strategies and hence boost their sales.
Prolonging payments may also lead to accumulation of interest. Therefore if the company is to agree on the 12 month period, they may demand some interest from bank. The bank on the other hand would not be willing to pay more for what they had earlier on projected. However, with the involvement of the relevant authorities, the two are able to strike a compromise which will ensure than none of the players feels duped into the transaction.
In addition, should bank all currencies into US dollars at the prevailing exchange rates, there is a very high probability that the bank will make huge losses as a result of this initiative. The success rates of exchanging huge currencies are usually very small and the risks involved are also higher. The exchange rates can change positively or negatively depending on the prevailing economic situations in the affected country. The exchange rate on currency is always fluctuating and if the bank decides to exchange all its currencies in US dollars, it risks running into huge losses. One way of mitigating risks on foreign exchange is through spreading trades over several pairs of currencies. Putting all the investments into one currency and then the currency drops can lead to a loss of an immense deal of money. If the trade is further spread out, then the chances of some of the currencies increasing in value are high and hence the bank can make profits from that. The act of converting all its currencies into US dollars can be disastrous to the bank and the management needs to evade such an act by all means. There are about 90% chances that the bank will make a loss as a result of converting all its currencies into US dollars.
. Therefore, whichever way chosen by the bank, there are some significant benefits as well as some short falls that can affect the operation of the bank. Having all factors constant, for example holding to the fact that the value of the US Dollars shall have not changed much by the end of the 12 month period, then the bank should consider the 12 month period of offer so that they can strengthen their reserves as they pay the offer.
- The bank is paying a sure sum of $2,150,000 to Corvette with two options of either 3 month period or 12 month period.
- The bank decides to convert all its currencies to US Dollars.
- The bank seeks other alternatives to finance its operations.
- The bank uses VAR model to determine the amount that could be lost on an investment portfolio over a given period of time.
- The bank should invest in other currencies so as to reduce the amount of risks in uncertainties of foreign exchange.
- The bank should get a compensational scheme to help it compensate on the amount of revenue offered to HSBC.
- The bank should employ competent risk managers to help in analyzing the risks and help in providing a tangible and workable recommendation.
- Converting part of their local and foreign currency reserves to cater for the costs
- Investing the money in their reserves in stock exchange
- Introducing the trading of several pairs of the foreign currencies.
- Find the distribution and report the mean and the standard deviation of the uncertain revenue in $
The provided data has a normal distribution with a mean of 2175398.2 and a standard deviation of 45833.
- What is the probability that this revenue will exceed $ 2,250,000?
Using the above values Pr = 0.0463
- What is the probability that this revenue will not exceed $ 2,500,000?
Using the above values; if P (X>x) = 0.0463 and x = 2,500,000
Then the P(X