ASSIGNMENT 1: CASE

STUDY
LECTURER: WIL MARTENS

Vu Ha Khanh Huong INTERNATIONAL FINANCE

31/3/20202
s3746878 BAFI3200
 Part A

1. Volkswagen AG (VW) is Europe’s biggest carmaker and was a publicly traded and closely held German-based
auto and coach manufacturer. It is stated that Volkswagen had the most substantial U.S exposure, and it was
expected to increase, yet it had the lowest level of natural hedging in the sector. Volkswagen had focused more
on treasury function and imposed a corporate-level currency hedging program due to the global recession during
1992 and 1993, making the firm suffer heavy losses. Firstly, the company implied the exchange rate pass-
through strategy referring to the process of passing changes in the exchange rate to the pricing of the final
product. However, the strategy is only suitable for Volkswagen models competed in the price-inelastic market,
such as its Jetta version. Secondly, the firm started purchasing a series of put options on the U.S dollar in 2000.
The options allowed the firm to be able to exchange the U.S dollars generated through North America sales into
euros at certain exchange rates in the future. Throughout 2002 and early 2003, the firm continually increased its
put option hedge purchases; hence, it was 100% hedged for sales through the 2006 model year. Additionally, the
firm had created a three-year rolling portfolio of put options to perform the strategy successfully. Thirdly, in 2001,
the company’s leadership had implemented a currency hedging strategy when the euro was recorded at a low
level against the U.S dollar. Notably, the firm was long-term long dollars since the company’s sales occupied
45% in North America and was expected to climb with the growth of the Touareg. Ultimately, the firm had not
possessed any manufacturing outside Europe to prevent the exchange rate exposure.

2. It is reported that BMW, Mercedes, Porsche and VW were indeed the most exposed to exchange rate fluctuations
among European-based automobiles; they were primarily subjected to the USD/EUR. Therefore, the dominant
European automakers were extremely cognizant and concerned over corporate currency exposures. Volkswagen
managed its exchange rate exposure by purchasing put options with strike prices beginning at $0.9/€, and
increasing in following years to $1.00/€ as the firm had believed that the U.S dollar would depreciate. Since the
firm was locked in put option strike rates at the time of the euro’s historical weakness, the company had obtained
affordable protection against a strengthening euro in the upcoming years. The firm’s competitors also hedged by
using derivatives; however, unlike VW which applied 100% derivatives in hedging, its rival only implied
derivatives with a small portion in their hedging strategies, as shown in figure 5 in the case study. In addition to
the hedging with derivative, VW only produced its products in two countries – Germany and Finland, which were
euro-denominated economies; while its competitors applied natural hedging. Mainly, BMW intended to double
the capacity of its Spartanburg, South Carolina manufacturing facility; while Mercedes also planned to expand
the capacity of its Alabama manufacturing facility and considered the downsizing of its Magna Steyr operations
located in Germany. Porsche planned to accelerate its operating cost base in Brazil since they believed that it
would be exclusively positioned to manage its U.S dollar risks and had declared that all of its Boxster and Spyder
would be assembled in Brazil or Mexico which roughly contributed 4% of Porsche’s group output.

3. In my opinion, the company’s current currency hedging strategy is quite effective in mitigating the adverse
exchange rate changes. According to figure 5 in the case study, Volkswagen’s currency exposure was covered
100% by put options during 2003 and 2005 due to the fear of increasing in euro value. By hedging with put option
100% in 2003, the firm had gained from the hedging strategy in 2002/03 and expected to be even more significant
in subsequent years. Indeed, the company had avoided the appreciation of the euro in the following years by
locking in put option strike rates when the euro depreciated against the dollar. As for the long-term long dollar
strategy, the firm could gain earnings in North America through the strategy when the U.S dollar falls in value.
 However, the firm would suffer huge losses when the movement of dollars is not expected, and the sales of
Touareg decreases. Hence, this strategy is not practical to hedge currency exposure. Furthermore, instead of
applying natural hedging, the firm assembled its cars in euro-dominated countries. Based on table 1 in the case
study, the company had 42% of global sales in North America and an additional 11% in the United Kingdom and
had possessed no manufacturing in both countries. Hence, Volkswagen’s products price would be exposed to the
exchange rate fluctuations without natural hedging. However, the firm had applied the exchange rate pass-through
strategy to minimize the exposure of exchange rate movements to its products’ prices. Although the price would
be added up by the pass-through, the company was still confident in leading in the price-elastic segment since the
firm’s current belief was to compete on quality and quantity. In short, Volkswagen’s current hedging strategies is
luckily effective enough for its operations resulting in an increase in its revenues.

4. According to figure 3, the EUR/USD spot rates during 2012 and 2014 experienced a gradual increase meaning
that the Euro appreciated against the dollars. However, Volkswagen’s sales from 2012 to 2014 unexpectedly
accelerated from 192,676 to 202,458, as shown in figure 7 in the case study. This indicates that the movement of
Euro had not impacted on the total sales of the company. Normally, when the Euro’s value appreciated, the total
sales of the company should have declined; as a result, the movement of the Euro would not have been favorable
for Volkswagen. However, the total sales of Volkswagen still steadily went up. This is due to its current hedging
strategies which had been implied since 2000. As a result, the firm had been less exposed to the exchange rate
fluctuations. Since the firm’s total sales performed well during the experienced years, their share price also
witnessed a rapid increase.

Part B

𝐽𝑃𝑌 𝑈𝑆𝐷 1 1
5. • The JPY/CHF exchange rate: 𝐽𝑃𝑌⁄𝐶𝐻𝐹 = 𝑈𝑆𝐷 × 𝐶𝐻𝐹 = 115.44 × 1.6933 = 0.00511

𝐶𝐻𝐹 𝑈𝑆𝐷
• The CHF/JPY exchange rate: 𝐶𝐻𝐹⁄𝐽𝑃𝑌 = 𝑈𝑆𝐷 × 𝐽𝑃𝑌
= 1.6933 × 115.44 = 195.4746

1
• The new JPY/CHF rate would be: 𝐽𝑃𝑌⁄𝐶𝐻𝐹 = 195.4746×(1+0.1) = 0.00465

• The new JPY/CHF rate would be: 𝐽𝑃𝑌⁄𝐶𝐻𝐹 = 0.0051 × [1 + (−0.25)] = 0.00383

6. CURRENCY TO EUR BHT CHF KRW USD

CONSIDER (A) (B) (C) (D) (E)
ANSWERS A D D D A

7. Vietnamese Taiwan Indonesian Egypt

US dollar
Dong Dollar Rupiah Pound
1 Egypt 5.9754 0.0003725 0.1589 0.000639 -
2 Indonesia 9356.5979 0.5833 248.845000 - 1565.8530
3 Taiwan 37.6001 0.002344 - 0.004019 6.2925
4 Vietnam 16041.0 - 426.6212 1.7144 2684.5065
5 US - 0.00006234 0.0266 0.0001069 0.1674
30,000,000,000
8. • 𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛 𝑑𝑜𝑙𝑙𝑎𝑟 = + 50,000,000 = $150,000,000
300

4,500,000,000

• 𝐴𝑛𝑛𝑢𝑎𝑙 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 = 300

150,000,000
× 100 = 10%

1
• The new exchange rate would be: 𝑈𝑆𝐷⁄𝐹𝑜𝑟𝑖𝑛𝑡𝑠 = 1 = 400
×[1+(−0.25)]
300