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EXECUTIVE SUMMAY:
Sales had increased by 12 percent in 1997 compared to the previous year, which is very close to budget. Merton Electronics (Merton), however, experienced over 40 percent drop in its earnings. Understanding falling margins for price-cutting competition, Merton believed that the volatility of the yen, and more recently, the Taiwanese dollar affected its bottom line. Over 60 percent of Merton’s purchases are exposed to currency fluctuations and the exposure to yen is substantial.
As a result, Merton now reviews the impact of foreign exchange rate and its hedging strategy. Despite the series of rather negative outcomes of their recent currency hedging strategies, Merton is still recommended to carry some type of currency hedging in the future. They should understand that Merton is not in the currency investment business but in the consumer electronic business.
CHOICES OF HEDGING:
Foreign currency hedging can be done in many different ways. Three most common and practical currency hedging vehicles for Morton can be forward contracts, currency options and spot contracts combined with the money market hedge. Still, more different options, including Interest rate options, foreign currency swaps, interest rate swaps and more are also available.
• Money market hedging (spot contracts combined with the money market hedging): Merton can buy yen when purchase order is issued to the vendor in Japan. Then, put it in a yen time deposit or some other yen asset until needed to pay the suppliers. Merton could use this strategy to eliminate the risk of the appreciation of yen but take the risk of the yen depreciation. This hedging method is not considere ...