The Ride Lugged School of Bidnez, Man
Consider some problems faced by Manzini Cyclery, a small U.S. maker of custom bicycles:
1) In December 2002, when the exchange rate was $1 per Euro, Manzini ordered parts for next year’s production from Campagnolo. They agreed to a price of 500,000 euros, to be paid when the parts were delivered in one year’s time. One year later, the exchange rate was $1.22 per euro. What was the actual cost in dollars for Manzini when the payment was due? If the price had instead been set at $500,000 (which had equivalent value at the time of the agreement), how many euros would Campagnolo have received?
2) In December 2002, banks were offering one-year currency forward contracts with a forward exchange rate of $0.987/€. Suppose that at that time, Manzini placed the order with Campagnolo with a price of 500,000 euros and simultaneously entered into a forward contract to purchase 500,000 euros at a forward exchange rate of $0.987/€ in December 2003. What payment would Manzini be required to make in December 2003?
Answers in the comments! Don’t cheat!
8 Comments so far
Leave a reply
Solution to #1:
With the price set at 500,000 euros, Manzini had to pay ($1.22/euro) X (500,000 euros) = $610,000. This cost is $110,000, or 22% higher than it would have been if the price had be set in dollars.
If the price had been set in dollars, Manzini would have paid $500,000, which would have been worth only $500,000 ÷ ($1.22/euro) = 409,836 euros to Campagnolo, or more than 18% less.
Whether the price was set in dollars or euros, one of the parties would have suffered a substantial loss.
Solution to #2:
Even though the exchange rate rose to $1.22/€ in December 2003, making the euro more expensive, Manzini would obtain the 500,000 euros using the forward contract at the forward exchange rate of $0.987/€. So, Manzini has to pay 500,000 euros X $0.987/euro = $493,500 in December 2003.
Manzini would pay this amount to the bank in exchange for 500,000 euros, which are then paid to Campagnolo.
This forward contract would have been a good deal for Manzini because without the hedge, it would have had to exchange dollars for euros at the prevailing rate of $1.22/€, raising its cost to $610,000. However, the exchange rate could have moved the other way. If the exchange rate had fallen to $0.85/€, the forward contract still commits Manzini to pay $0.987/€. In other words, the forward contract locks in the exchange rate and eliminates the risk – whether the movement of the exchange rate is favorable or unfavorable.
dear god man. i’ll call you next time i need a half a million bucks worth of campy shit. sometime next week i imagine.
Possible outcome #1:
Campagnolo alienates it’s US customer base by changing the front shifter in such a way that it no longer has micro trim. At the same time, their US based customer service manages to piss of smarmy busybody frame builder Richard Sachs who “MAKES THE LEAP” and manages to pull his toadies along with him. Campagnolos market share in the US becomes nearly irrelevant and campyonly.com falls into internet darkness.
Question 1: Is Campy sill relevant?
Question 2: How long will it take Sachs to find this and comment? I’m taking bets. I say 7 hours.
Sachs sucks. frames look pretty good though…
I can’t believe it. He’s purposely not commenting to spite me…again.
question 1=500, euros…that never changed…
question 2= wtf?
I meant 500,000 euros for #1