Curtis Inc is a US manufacturer of heavy construction equipm

Curtis Inc. is a U.S. manufacturer of heavy construction equipment used in the construction of deep water ports and heavy lift capacity airports. Curtis is headquartered in Michigan, and has just received an order from a Pakistani Construction Company not known to you or to Curtis. The order is for two of your largest earth movers with the total sale price of e30.0 million euros. The Pakistani company requires Curtis to ship upon completion of manufacture and will pay the e30.0 million to you six months from shipment.

Global Financing (a Commercial Bank of which you are President and Chief Lender) is the international financier hired to put this financial transaction together and make it happen, (so don\'t make this a career limiting opportunity)!

Cost of funds is 4.75% (LIBOR)
Confirmation fees are 65 basis points
Negotiation fees are 12 basis points
Discount Commission is 30 basis points
Spot euro is $1.4950
90 day euro is $1.4975
180 day euro is $1.5000
Banker\'s Acceptance rates are 4.96%

Issues to consider:
The Pakistani\'s cannot pay for 180 days from shipment
Curtis wants it\'s money as soon as shipment is made

1. What are the many different ways you can make money from this transaction without taking any undue risk

2. How would you cover yourself for Pakistani risk

3. What other risks do you have (financial and otherwise), explain how to mitigate

Solution

Ans;

a)

Ways to make money without any risk:

Supply the goods under letter of credit guaranteed by home country bank

Supply the goods under LC and factor the receivables

Supply the goods subject to credit guarantee from banker

Forward cover against currency risk

b)

Cover against pakistani risk:

Supply the goods under LC guaranteed by home country bank

c)

Other risk:

If goods is supplied CIF then risk of transit loss, can be mitigated through proper insurance policy

Currency fluctuations, can be mitigated through forward cover

Equilibrium

Spot rate

1.495

180 days forward rate

1.5

Interest rate parity

Forward rate = spot rate*(1+interest rate of other country )/(1+interest rate of home country interest rate)

Calculating UK interest rate by applying interest rate parity (1.495*1.0475)/1.50 - 1

2.03%

Accordingly if UK interest rates are 4.06% then Euro and dollar price will be in equilibrium else it will not be.

d)

Money to be received:

Gross sales value

        300,00,000.00

Euro

Confirmation fee (30000000*.65%)

             1,95,000.00

Negotiation fee (30000000*.12%)

                36,000.00

Discount commission (30000000*.30%)

                90,000.00

Acceptance rate (30000000*4.96%*180/360)

             7,44,000.00

Cost of funds (30000000*4.75%*180/360)

             7,12,500.00

Net money received

        282,22,500.00

Net money dollar

        421,92,637.50

USD

Yield

94.08%

(42192637 / 30000000*1.495)

e)

Investment instrument:

Receivable created out of this sales transaction can be factored and it will create a new financial instrument

This will be a revenue opportunity and will provide immediate cash to the seller and will avoid exchange risk as well

Amount to be received will be gross receivables reduced by factoring cost

Assuming factoring cost is equivalent to cost of funds, amount will be calculated as per below:

Gross receivables

        300,00,000.00

Euro

Gross receivables

        448,50,000.00

USD

Less: Factoring cost (44850000*4.75%*180/360)

          10,65,187.50

USD

Net amount received

        437,84,812.50

USD

f)

Foreign exchange risk elimination:

Taking forward cover

Cover will be taken on the date of transaction

Amount to be received under forward cover and eliminating currency risk

Gross receivables

        300,00,000.00

Euro

180 days forward rate

                           1.50

Receivables fixed in USD value without any currency risk

        450,00,000.00

USD

g)

Instrument to ensure performance of both the parties:

Performance LC can be used as a tool to ensure performance of both the parties

It will be initiated by buyer and will be sent to seller through seller\'s home country bank and it will obligate the seller to ship the goods at agreed date and will ensure payment to seller at agreed date.

a)	Ways to make money without any risk:
	Supply the goods under letter of credit guaranteed by home country bank
	Supply the goods under LC and factor the receivables
	Supply the goods subject to credit guarantee from banker
	Forward cover against currency risk
b)	Cover against pakistani risk:
	Supply the goods under LC guaranteed by home country bank
c)	Other risk:
	If goods is supplied CIF then risk of transit loss, can be mitigated through proper insurance policy
	Currency fluctuations, can be mitigated through forward cover
	Equilibrium
	Spot rate	1.495
	180 days forward rate	1.5
	Interest rate parity	Forward rate = spot rate*(1+interest rate of other country )/(1+interest rate of home country interest rate)
	Calculating UK interest rate by applying interest rate parity (1.495*1.0475)/1.50 - 1	2.03%
	Accordingly if UK interest rates are 4.06% then Euro and dollar price will be in equilibrium else it will not be.
d)	Money to be received:
	Gross sales value	300,00,000.00	Euro
	Confirmation fee (30000000*.65%)	1,95,000.00
	Negotiation fee (30000000*.12%)	36,000.00
	Discount commission (30000000*.30%)	90,000.00
	Acceptance rate (30000000*4.96%*180/360)	7,44,000.00
	Cost of funds (30000000*4.75%*180/360)	7,12,500.00
	Net money received	282,22,500.00
	Net money dollar	421,92,637.50	USD
	Yield	94.08%
	(42192637 / 30000000*1.495)
e)	Investment instrument:
	Receivable created out of this sales transaction can be factored and it will create a new financial instrument
	This will be a revenue opportunity and will provide immediate cash to the seller and will avoid exchange risk as well
	Amount to be received will be gross receivables reduced by factoring cost
	Assuming factoring cost is equivalent to cost of funds, amount will be calculated as per below:
	Gross receivables	300,00,000.00	Euro
	Gross receivables	448,50,000.00	USD
	Less: Factoring cost (44850000*4.75%*180/360)	10,65,187.50	USD
	Net amount received	437,84,812.50	USD
f)	Foreign exchange risk elimination:
	Taking forward cover
	Cover will be taken on the date of transaction
	Amount to be received under forward cover and eliminating currency risk
	Gross receivables	300,00,000.00	Euro
	180 days forward rate	1.50
	Receivables fixed in USD value without any currency risk	450,00,000.00	USD
g)	Instrument to ensure performance of both the parties:
	Performance LC can be used as a tool to ensure performance of both the parties
	It will be initiated by buyer and will be sent to seller through seller\'s home country bank and it will obligate the seller to ship the goods at agreed date and will ensure payment to seller at agreed date.