Ritchie Ltd

Ritchie Ltd. A New Zealand based entity, has been expanding sales revenue by exporting
woollen boots to the U.S and China. These boots are assembled in New Zealand using New
Zealand produced wool and other materials. Ritchie has made the decision to exclusively use
New Zealand wool because of its relatively high quality compared with the U.S and Chinese
alternatives. Other materials are purchased in New Zealand to complement a just in time
production process.

All of Ritchie’s export revenues will be in the currency of the country where the boots are sold.
So if the boots are sold in the U.S, Ritchie would receive USD in exchange. To export to the
U.S and China was an easy decision in some respects. The U.S has a high average income, and
besides sales to customers who wish to be trendy, the country has many colder areas. The
interest in China follows on recent trade missions by the New Zealand government. China is
one of the fasters growing markets in the world and certainly in the Asia-Pacific region.
Existing contracts with importers will last another 18 months and may be renewed if everyone
is happy then. The boots are being sold for US$ 50 a pair in the U.S and CNY 413.73 in China.
They are currently produced in New Zealand and transported overseas for a cost of NZ$ 35.71
a pair. However, there is significant competition from other countries because the boots are
popular and relatively easy to manufacture. But only one company, Ritchie is selling boots
made exclusively with NZ wool. For the next year Ritchie expects to manufacture 750000 pairs
for export and sell 50% in the U.S and 50% in China.

As a member of the treasury team at Ritchie, you have been asked to consider export risks and
compile a report on them for the treasurer. You are concerned that trade negotiations between
the U.S and New Zealand have hit new lows because of the U.S economy has not done well in
the recent past. You are also worried that the growth that China has experienced recently will
not be sustainable and that the importers may not wish to renew the contract with Ritchie if
they cannot sustain current sales levels. You are also worried that the New Zealand dollar has
peaked at historical highs and is beginning to fall because of large current account deficit, a
slowdown in the domestic economy and the recovery of the US economy.

To conduct your analysis and report you have collected the following information-

a. Variable costs are expected to increase at or slightly below the current inflation rate in
NZ of 2% pa.
b. Given the competitive environment, there is little scope for an increase in the price per
pair of the boots in the next year to 18 months.
c. Ritchie has no debt in its capital structure but has the ability to borrow if necessary.
d. Fixed costs that need to be covered are NZ$300000.
e. The current exchange rates are NZ$1.400/USD and CNY8.2745/USD. Given past
exchange rate volatility, you believe that these spot rates could either go up or down by
10% over the next year or remain the same. Do not worry about the bid ask spreads in
your analysis.
Questions-

1. What are the types of risks faced by Ritchie?

2. For the initial exchange rates, undertake a cash flow analysis and indicate the extent of
the economic exposure for Ritchie if US and Chinese exchange rates appreciate or
depreciate.
3. How could Ritchie reduce its exposures?

Inter Globe Aviation Ltd placed an order to buy 100 aircrafts from Airbus Industries limited.
The payment will be made in instalments of which 500 million Euros is payable one year from
now-

Spot rate- € =₹70.95/70.98

1 year Forward Rate- € =₹74.43/74.50

1 year Future rate - € =₹74.25/74.45

1 year Euro Interest rate- 0.5%-1%

1 year Indian Rupee Interest rate- 6.5%-7.5%

I year call option at a strike price of € =₹74.50 is trading at a premium of 1.5 and I year put
option at a strike price of € =₹72.50 at a premium of 0.8

a. What is the hedged value of Inter Globe Aviation Limited’s payables using the forward
market hedge and money market hedge? How will Inter Globe Aviation hedge in money
market?
b. What is the hedged value of Inter Globe Aviation Ltd’s payable in future contract?
c. What alternatives are available to Inter Globe Aviation to use currency options to hedge
its payables? Which option strategy would you recommend?
d. At what exchange rate the cost of the option is just equal to the cost of the forward
market hedge?
e. How can Inter Globe Aviation construct a currency collar?