Hedging transaction exposure. Popescu, Hagi & Associates Milagros Chavez Valdivia Sayyada Vazir

Introduction Popescu, Hagi & Associates (PHA) is a consulting firm that specializes in derivatives. DW Inc., a manufacturing company hires PHA to help create a predictable cost structure. DW orders parts from Japan at a cost of 200,000,000 JPY Parts will be delivered in March. Estimated payment April 17.

PART I. December 6, 2012 Normal Distribution Simulation Best - Worst case scenario: 2,126,263 USD - 2,759,661 USD VaR(99%): 2,690,054 USD Simulation VaR(99%): 2,759,661 USD

PART I. December 6, 2012 PHLX Options Total amount to be paid: 200,000,000 JPY 1,000,000 JPY = 1 contract Number of contracts = 200 PHLX Options (premium in cents per unit): Call Put JPY June 0.008 0.45830 0.00407 JPY June 0.009 0.36255 0.01052 JPY June 0.010 0.29542 0.01425

PART I. December 6, 2012 PHLX Options (Cont.) Total Premium = Rate/100 * 200,000,000 Carrying Cost = Total Premium * (Daily interest rate/100*Time) Daily interest rate = 0.00201 Time = 132 days from 12/6/2012 to 4/17/2013 PHLX JPY June 0.008 JPY June 0.009 JPY June 0.010 Total premium paid in USD 916,600.00 725,100.00 590,840.00 Carrying cost (CC) USD 2,433.94 1,925.43 1,568.92 Total premium cost 919,033.94 727,025.43 592,408.92

PART I. December 6, 2012 PHLX Options (Cont.) St < .008 Cash Flow St*(200,000,000 JPY) 1,600,000 1,800,000 2,000,000 Premium 919,033.94 USD 727,025.43 USD 592,408.92 USD Total Cash Flow (St*(200,000,000)+ 919,033.34) USD 2,519,033.94 USD (St*(200,000,000)+ 727,025.43) USD 2,527,025.43 USD (St*(200,000,000)+ 592,408.92) USD 2,592,408.92 USD

PART I. December 6, 2012 OTC Options: OTC Strike price 0.009 Total premium paid in USD 816,200.00 639,520.00 Carrying cost (CC) USD 2,167.34 1,698.18 Total premium cost 818,367.34 641,218.18

PART I. December 6, 2012 OTC Options (cont.): St < .009 Cash Flow St*(200,000,000 JPY) 1,800,000 2,000,000 Premium 818,367 USD 641,218 USD Total Cash Flow (St*(200,000,000)+ 818,367.34) USD 2,618,367 USD (St*(200,000,000)+ 727,025.43) USD 2,641,218 USD

PART I. December 6, 2012 Forwards: Total amount to be paid= 200,000,000 JPY Spot rate = 0.01247 USD/JPY 3-mo USD Interest rate (%) = 0.18105. Daily USD Interest rate (%) = 0.00201 3-mo JPY Interest rate (%) = 0.10100. Daily USD Interest rate (%) = 0.00112 Forward (132 days) = 0.0124846 USD/JPY On April 17, we will pay with certainty = 2,496,928 USD

PART I. December 6, 2012

PART II. May 6, 2013 Parts arrived on April 11, 2013 Payment is due in 5 days on May 11, 2013 Spot rate is .01004 USD/JPY

PART II. May 6, 2013 Effective total cost (USD) using 3-months Forwards Rate of 3 month forward contract on December 6, 2012 is 0.012494 USD/JPY 2,498,800 USD will be payable on March 6th, 2013 DW can then invest the 200,000,000 JPY for 2 months to earn interest Daily interest rate = 0.1505/180 = 0.00084211 200,000,000 * (0.00084211/100*60) = 101,053.33 JPY earned in 60 days 101,053.33 * 0.01004 = 1,014.58 USD Total cost = 2,498,800 -1,014.58 = 2,497,785.42 USD

PART II. May 6, 2013 Effective total cost (USD) using 6-months Forwards Rate of 6 month forward contract on December 6, 2012 is 0.012561 USD/JPY 2,512,200 USD payable on June 6, 2013 On May 6, 2013 sell a 1 month forward at a rate of 0.010464 USD/JPY At expiration, 419,400 USD receivable Today’s value of receivable = 419,019 USD Total cost = 2,093,181 USD

PART II. May 6, 2013 Effective total cost (USD) using June Futures Total amount to pay on May 11, 2013 (JPY) is 200,000,000 JPY 16 contracts valued at 12,500,000 JPY each Spot rate December 6 (USD/JPY) is 0.01247 Total cost = 2,466,400 USD 6-Dec-12 6-May-13 Vt 200,000,000 V* 2,494,000 2,008,000 St 0.012470 0.010040 Ft,6-mo 0.012570 0.010002

PART II. May 6, 2013 Effective total cost (USD) using OTC JPY Options Call option with Strike price .009 at cost 0.40810 (0.40810/100)*200,000,000 = 816,200 USD Cost Carrying cost = 1,209.06 USD Spot rate in May is = .01004 USD/JPY Exercise since strike price is lower than exercise price Total price = (200,000,000*.009) + (816,200+2,167.34) = 2,618,367.34 USD Call option with Strike price .010 at cost 0.31976 (0.31976/100)*200,000,000 = 639,520 USD Cost Carrying cost = 947.34 USD Total price = (200,000,000*.010) + (639,520+1,698.18) = 2,641,218.18 USD

PART II. May 6, 2013 Effective total cost (USD) using JPY June Options 0.010254>0.008 USD/JPY 0.010254>0.009 USD/JPY 0.010254>0.010 USD/JPY 2,519,034 2,527,025 2,592,409

PART II. May 6, 2013 Effective total cost (USD) leaving position open Spot rate May, 2013 = 100.83 JPY/USD Spot rate May, 2013 = 0.009918 USD/JPY Total Cost = 200,000,000 * .009918 = 1,983,537 USD