our life at Agri-Drone is now entering its second five years, and your world – your world of global finance – is getting interesting!
It’s been over three years since you introduced the Company to a combined and flexible, almost nimble, approach of using options and forwards to deal with the currency risks of your sales flow overseas.
And it was a good thing you did. The percentage of sales to international customers has steadily increased. The market buzz about the Company’s innovation has continued, and the second generation of your products has been very well received. All evidence points to continued expansion domestically and globally.
You now have currency hedges in place in three different countries structured with options. Most are offsetting sets of options, which of course bothers Jim, the VP of Sales, because he hates giving away the upside when currency trends would otherwise work in Agri-Drone’s favor. Yes, this is the same Jim that constantly moaned about having to pay a premium on a single option that allowed the Company to keep the currency upside. Oh well, Jim will always be Jim and you suspect every company has one.
But all that is just extra noise at this point. You have much bigger fish to fry because things are about to get really interesting on two fronts. This morning, the Board of Directors is being briefed by CEO Stephanie Majors on her expansion plan. First, she believes that sales to only three different countries will soon be a distant memory. She predicts international sales are easily going to double. Second, there is no way those sales goals can be met without some international supply and fabrication.
As you see her confidently return to her office from the board meeting, you wonder how many Monday Night Football games you’ll be missing because of this strategy.
“What? We have to do something about this?
As it turns out, you will likely miss quite a few games based on today’s follow-up conversation with Stephanie.
“So, we’re expanding our sales network globally,” you begin. “Do we know where?”
“Oh, right,” Stephanie responds, peering at you sharply. “I bet that matters. But to answer your question, we’ll probably be expanding in Asia and South America.”
“Anything more specific?”
Stephanie clears her throat. “Well, India and Brazil are pretty sure bets, but we’re still unsure about the others.”
“It will help to know as soon as possible.” You pause and then continue. “On the international supply and fabrication front, where do you think we’ll be importing from?”
“Not sure. Does it matter? I thought we only needed to hedge sales.”
“I tell you what,” you offer, frowning. “Let me put together a non-specific mock-up so you can see how this all works.”
Assume Agri-Drone sells to new customers in non-U.S. countries 1, 2, and 3 in amounts equal to $5,000,000 each. Assume as well that $10,000,000 worth of the sales will be produced by a vendor in Country 2 at a fully absorbed cost of $8,000,000. Finally, assume that the spot prices (in dollars) for one unit of each currency are 1.3000, .9200 and .7400, respectively. Now, build an example for the CEO that shows how to organize this data in order to simplify the currency risk mitigation process, regardless of specific method chosen to do so.
The good news is that, with your guidance, CEO Stephanie Majors is beginning to understand the problem you face and where, at least conceptually, the risks are most pronounced. The bad news is you know that this is just the tip of the iceberg. Instead of three countries, there will be at least a dozen soon. Instead of one non-US supplier and/or fabricator, there will be at least three.
As you ponder this “three-dimensional currency cube,” you ask yourself two questions, which represent the next problem:
1. Do we have to deal with all of the currency pairs we encounter?
2. Of those that we have to deal with, do we have to deal with each of them separately?
Answer each of these questions supported by a reasoned answer as to Why? or Why not?
As these tactical questions swirl in your thoughts, fairly straightforward answers emerge. But you wonder if you’re missing the big picture – possibly putting the cart before the horse.
And then it hits you. You’ve almost always had to react to situations in real time. You’ve never taken a step back to pause and think strategically. Now is that time, and three new questions emerge in Problem 3.
1. What is our objective in managing Agri-Drone’s currency risk?
2. How much risk are we willing to accept?
3. How much are we willing to spend to deal with the level of currency risk we are willing to accept?
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