Telefifa Case:Hedging, Exchange Rate Risks

T​‌‍‍‍‌‍‍‍‌‍‍‍‌‌‌‌‌‌‍‍​elefifa is a company engaged in the production and sale of telecommunication devices and it invoices in euros. In general terms, the company buys 60% of the materials used in the production of its devices from different companies from Asia and the US. The suppliers are chosen, on the one hand, regarding its low prices, and, on the other, regarding the high technological component of certain materials. The total amount of those purchases, very seasonal throughout the year, are made in USD. Payments are made at the end of each month. In the last years, the sector’s sales volume has not grown, although nothing seems to point to a reduction in activity as the current volumes remain constant.
 The number of competitors is seven, which, together with Telefifa, share equitably the overall sales in the country. According to forecasts for next year, the company will need to purchase $12 million, equivalent to $1 million per month. The increase in competition in the last years, which has led to a necessary reduction in the prices of the products, has forced the company to implement a significant policy of expenditure restraint in order to maintain profit margins. In addition, the company also suffers from slight liquidity problems. The company must also actively manage the exchange rate, which allows them to meet the budget set for the year in order to prevent that an unfavorable evolution of the exchange rate ruins their planned commercial margin and the company’s viability. 
On the other hand, and taking into account the importance of guaranteeing the period’s exchange rate, they are also aware that if they insure 100% of the expected purchase in USD, there is a possibility that other ​‌‍‍‍‌‍‍‍‌‍‍‍‌‌‌‌‌‌‍‍​companies that didn’t insure their purchases take advantage of that decision. This would lead to a reduction of the product prices in order to gain market share, which would be an unfeasible situation for Telefifa. For the analysis period, the company has established a payment goal that cannot surpass the equivalent of $1.2000 for each euro (1 euro = 1.2000 USD). Keep in mind that, for a Spanish company, this is an indirect quotation (a certain amount of local currency for each USD), while most currencies are quoted using direct quotation. 
The company calls the financial entity that provides their hedging instrument contracts and requests a quote for an import exchange rate insurance and for the purchase of a call option. The prices quoted are as follows (average prices for all expected payment dates): ? Forward. 1.2400 EUR/USD (better than 1.2000 EUR/USD). ? Call option. Strike: 1.2300 EUR/USD (premium to be paid: 0.0200 EUR/USD). ? Tunnel: 1.2000 – 1.2750 EUR/USD. The following questions regarding the case should be answered. ? What type of equity accounts, both in the balance sheet and in the income statement of this company, do you think will be affected by the risks mentioned above? ? Do you know any other hedging instrument, either natural or financial, to propose to the company? ? Would you cover 100% of the amount? Would you leave the position uncovered? Justify your answer. ? Which strategy would you apply to achieve the company’s objectives? We assume that the USD could reach several scenarios: 1.1400, 1.1800, 1.2200, 12.400, 1.2800, 1.3200 and 1.3400. What would be the average change according to the strategy decided? The paper should be written in Calibri 12 line​‌‍‍‍‌‍‍‍‌‍‍‍‌‌‌‌‌‌‍‍​ spacing 1.5.
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