You are on page 1of 4

PIXONIX INC.

- ADDRESSING CURRENCY EXPOSURE

Karim A. Moolani wrote this case under the supervision of Professor Colette Southam solely to provide material for class discussion.
The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised
certain names and other identifying information to protect confidentiality.

Ivey Management Services prohibits any form of reproduction, storage or transmittal without its written permission. Reproduction of
this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to
reproduce materials, contact Ivey Publishing, Ivey Management Services, c/o Richard Ivey School of Business, The University of
Western Ontario, London, Ontario, Canada, N6A 3K7; phone (519) 661-3208; fax (519) 661-3882; e-mail cases@ivey.uwo.ca.

Copyright © 2008, Ivey Management Services Version: (A) 2008-06-05

On Friday November 2, 2007, Mikayla Cain, chief financial officer of Pixonix Inc., sat in her office and
pondered the impact of the strong Canadian dollar on her firm’s projected financial results. The Report on
Business today stated that the Canadian dollar had hit another record, jumping to US$1.0717 from the
previous day’s close of $1.0512 after a stronger-than-expected jobs report reduced the odds of an interest-
rate cut. The Canadian dollar had already been the world’s best-performing major currency this year,
increasing 25 per cent against the U.S. dollar and almost seven per cent in the past month alone. Cain knew
she would have to understand the impact of the strong dollar on her firm’s cash flows and the tools available
to manage the company’s currency risk.

THE COMPANY

Pixonix was a graphic design company that operated in Toronto, Canada. At an annual cost of US$7.5
million, the company licensed proprietary tools and software through a U.S. company; this payment was
due at the end of January each year. While all of the company’s revenues were denominated in Canadian
dollars, a significant portion of its expenses were paid in U.S. dollars. Therefore, Pixonix had to annually
convert its Canadian dollar cash flows into U.S. dollars. As the Canadian dollar strengthened, cash flow
and profitability had been positively impacted, but Cain faced a considerable amount of uncertainty about
the value of the Canadian dollar at the end of January, when she would have to purchase US$7.5 million.

RECENT HISTORY OF THE CANADIAN DOLLAR

At times during the early 1970s, the value of the Canadian dollar was higher than that of the U.S. dollar,
reaching a high of US$1.0443 on April 25, 1974. During the technological boom of the 1990s, the Canadian
dollar fell relative to the U.S. dollar and traded at a record low of US$0.6179 on January 21, 2002. Since
then, its value had risen, in part due to the high price of Canada’s commodity exports (primarily oil). The
Canadian dollar’s value against the U.S. dollar rose sharply in 2007, owing to the continued strength of the
Canadian economy and the U.S. currency’s recent weakness. On September 26,
Page 2 9B08N013

2007, the Canadian dollar was trading at parity with the U.S. dollar for the first time since November 25,
1976. On September 28, 2007, the Canadian dollar closed above the U.S. dollar for the first time in 30 years
and had today hit an all-time high since official record-keeping began. RBC, the largest international trader
of Canadian dollars, raised its forecast for the currency on Friday, saying it would appreciate further to
around US$1.08 before declining below parity in the second half of next year.

HEDGING VEHICLES

Cain had investigated various vehicles for hedging the company’s foreign exchange risk, including call
options, put options and forward contracts.

An option is a financial contract between two parties, the buyer and the seller (referred to as the writer) of
the option contract. The buyer of the option has the right, but not the obligation, to buy or sell a pre-
determined quantity of a particular security (or other financial asset) at a certain time for a pre-determined
price (the strike price). The buyer pays a fee (premium) for this right, and risk is limited to the premium
paid. Exact specifications differ depending on the type of option. A ‘European’ option allows the holder to
exercise the option only on the expiration date, while an American call option allows exercise at any time
during the life of the option.

A call option allows the buyer to purchase a particular asset, and the seller is contractually obligated to sell
the asset should the buyer choose to exercise his/her right to purchase. The buyer of the call option believes
that the price of the underlying asset will rise (bullish outlook), whereas the seller believes that the price of
the asset will fall (bearish outlook). Call options increase in value when the underlying instrument increases
in value. When the price of the underlying instrument is greater than the strike price, the option is said to be
“in the money.” When the price of the underlying instrument is less than the strike price, the option is said
to be “out of the money.”

A put option allows the buyer to sell a particular asset, and the seller is contractually obligated to buy the
asset should the buyer choose to exercise his/her right to sell. The buyer of the put option believes that the
price of the asset will fall (bearish outlook), whereas the seller believes that the price of the asset will rise
(bullish outlook). Put options increase in value when the underlying instrument decreases in value. When
the price of the underlying instrument is less than the strike price, the option is said to be “in the money.”
When the price of the underlying instrument is greater than the strike price, the option is said to be “out of
the money.”

A forward contract is a contractual agreement between two parties to buy or sell an asset at a pre-agreed
future point in time at a pre-determined price. Forwards are typically used to control and hedge risk. In this
particular contract, one party agrees (is obligated to) to sell and the other party is obligated to buy; the
exercise of a forward contract is not optional. The forward price of the contract is typically compared to the
spot price for the asset, which is the price at which the asset currently trades. The difference between the
spot and the forward price is typically referred to as the forward premium or forward discount. A
standardized forward contract that trades on an exchange is referred to as a futures contract.
Page 3 9B08N013

POTENTIAL STRATEGIES

Cain had two strategies in mind to address the firm’s currency exposure. The first strategy (herein referred
to as Strategy 1) that Cain was considering was to purchase a forward contract and lock in the cost of the
January U.S. dollar purchase of US$7 million. See Exhibit 1 for the current forward rate on the U.S. dollar.

A second strategy (herein referred to as Strategy 2) would be for Cain to purchase a U.S.-dollar call option
for $7.5 million. The result of this strategy would be to set an upper limit on the cost of her January purchase
of U.S. dollars. See Exhibit 2 for the current premiums on various U.S. dollar call and put options.

CONCLUSION

Cain was unsure about which hedging strategy to use. She was interested to see the impact of her hedging
strategies under different exchange rates.
Page 4 9B08N013

Exhibit 1

FORWARD RATES FROM HTTP://WWW.OZFOREX.COM.AU/CGI-BIN/FORWARDRATES.ASP


FRIDAY NOVEMBER 2, 2007

Spot Rate USD/CAD 0.9344/0.9351


Period Bid Ask (Offer)
1 Month 0.934330 0.935130
2 Months 0.934190 0.935010
3 Months 0.934160 0.934990
6 Months 0.934530 0.935510
12 Months 0.935620 0.936700
2 Years 0.938660 0.940940

Exhibit 2

EXCERPT FROM MONTREAL OPTIONS EXCHANGES ONLINE QUOTES FOR US$


FRIDAY NOVEMBER 2, 2007

Call Option Put Option


Bid Ask Last Bid Ask Last
YY/MM/Strike Price Price** Price YY/MM/Strike Price Price Price
+ 07 NO 93.500 0.74 0.79 0.79 + 07 NO 93.500 0.83 0.88 0.88
+ 07 NO 94.000 0.53 0.58 0.58 + 07 NO 94.000 1.12 1.17 1.17
+ 07 NO 94.500 0.36 0.41 0.41 + 07 NO 94.500 1.45 1.50 1.50
+ 07 NO 95.000 0.24 0.29 0.29 + 07 NO 95.000 1.83 1.88 1.88
+ 07 DE 93.500 1.39 1.44 1.44 + 07 DE 93.500 1.47 1.52 1.52
+ 07 DE 94.000 1.16 1.21 1.21 + 07 DE 94.000 1.74 1.79 1.79
+ 07 DE 94.500 0.95 1.00 1.00 + 07 DE 94.500 2.04 2.09 2.09
+ 07 DE 95.000 0.79 0.84 0.84 + 07 DE 95.000 2.36 2.41 2.41
+ 08 JA 93.500* 1.68 1.73 1.73 + 08 JA 93.500 1.74 1.79 1.79
+ 08 JA 94.000 1.45 1.50 1.50 + 08 JA 94.000 2.00 2.05 2.05
+ 08 JA 94.500 1.24 1.29 1.29 + 08 JA 94.500 2.29 2.34 2.34
+ 08 JA 95.000 1.06 1.11 1.11 + 08 JA 95.000 2.60 2.65 2.65

*To get the option premium, multiply the bid or ask price (expressed as a percentage) by the face value.