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VOYAGES SOLEIL: The Hedging Decision

VOYAGES SOLEIL: The Hedging Decision. Jennifer Gore, Lani Heinemann, Kimberly Kam, Ricky Lai and Nadejda Zaitchenko Dr. Greco - Finance 570 - April 30, 2009. Agenda. Company & Industry Background The Case Issues Alternatives Recommendation The Outcome Conclusion .

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VOYAGES SOLEIL: The Hedging Decision

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  1. VOYAGES SOLEIL: The Hedging Decision Jennifer Gore, Lani Heinemann, Kimberly Kam, Ricky Lai and Nadejda Zaitchenko Dr. Greco - Finance 570 - April 30, 2009

  2. Agenda • Company & Industry Background • The Case • Issues • Alternatives • Recommendation • The Outcome • Conclusion

  3. The Company • One of Canada’s leading tour operators in packaged vacations to the Caribbean and South America • Headquarters located in Quebec and established in 1975 • Jacques Dupuis is the president and owner • Built strong relationships with customers to lend to its leadership status in the industry

  4. The Company (Cont.) • Experienced sales growth of 50% from 1997 to 2001, but experienced 5% decline since 9/11 • Forecast for 2002 shows returns to pre-9/11 levels • Majority of clients are from Quebec • Most popular destination packages: French Caribbean, Costa Rica, Cuba, Florida and Mexico

  5. The Canadian Tour Operating Industry • Average growth rate between1998 and 9/11/2001 was greater than 8% • 9/11 attack slowed US economy in general, but especially affected the travel industry • Canadian travel to the US fell by 25% after 9/11 • Trips to Canada’s largest markets Florida and Mexico declined by 15% and 12% respectively • 30% to 50% decline in overall industry volume • 2 of 7 largest tour companies declared bankruptcy

  6. The Case • Clients pay in CAD, but vendors only accept USD - VS vulnerable to FX risk • April 1, 2002 deadline for VS to decide on its FX risk strategy for US$60 million in payables due October 2002 • CAD has been depreciating against the USD since 1998 • Canadian GDP reported to be 2.4% in March 2002 • Dupuis was faced with uncertainties about the ability to pay vendors if CAD continues to weaken

  7. Market Conditions Canadian Stock Market Index – (Exhibit 3) experiencing a great deal of volatility in recent years Canada experiencing large swings in inflation/deflation since 3Q 2001 These are both indicators that the Canadian market is volatile and unpredictable, likely due to more macro-economic factors that are affecting the Canadian economy

  8. Market Conditions

  9. Factors Contributed to CAD to USD Fluctuations Slower than expected recovery of financial market since the events of 9/11 High-profile corporate scandals US growing deficit United States possibly to go to war in the Middle East Overall weak economy, with business and consumer confidence expected to rise in 2002

  10. Opportunities Canadian economy should grow at a faster rate than the US in the next 1-2 years as CAD was not affected to the same extent by the events of 9/11 Lower interest rates could potentially encourage consumer spending in Canada VS should look into expanding its packages to European customers VS should also look into destinations that accept denominations other than USD to minimize their risk exposure

  11. Constraints Unable to predict real demand for travel packages Fulfillment of paid travel packages Hedging cost Cash Flow Justify FX Hedging decision to stakeholders (management, investors, or stockholders)

  12. Timeline 03/30 Make a decision 10/02 – 01/03 10/01 Payments Due 04/01 Finalize Contracts

  13. Basic Issues Importance Low High Urgency Supplier Relationships Economic Conditions Low Foreign Exchange Risk High Competition

  14. Immediate Issues Importance Low High Urgency Forecasted Demand Low Products Wait or Make a Bet? High Pricing

  15. Cause and Effect Lack of FX Hedging Strategy Decrease in Product Demand Threat to Short-term Profitability Economic Slowdown Industry Instability

  16. Assumptions • VS has enough resources to support all alternatives • Cash flow • Accounting and financing capabilities • 10/1/2002 – need $60 million USD available for accounts payables • Using the exchange rate of 0.6000 • Every $1 CAD = $0.60 USD • Alternative 1-3 (data from case) • Alternative 4 (data from 4/30/09)

  17. Decision Criteria Determine the best alternative with the following considerations: Minimize cost Maximize savings Minimize accounting exposure Least amount of currency risk exposure Ease of implementation

  18. Alternatives • Wait and use the spot rate at the time payables are due • Forward contract 6-month • Borrow CAD to purchase USD and invest USD for 6 months • Call option to purchase USD with a 6-month expiration

  19. X-rate prediction At current exchange rate of 0.6298 US$60M payable would cost Cdn$95,268,339.16 Under IFE Canadian dollar is expected to appreciate Under PPP Canadian dollar is expected to depreciate

  20. Alternative 1 Do nothing, exchange Canadian dollars in October

  21. Alternative 2 Forward contract for US$60 million locking in a 6-month forward rate at 0.6271 Regardless of what happens to exchange rates, CAD required = $95,678,520.17 Bank typically requires a 15% to 18% line of credit for this 6-month contract VS would need to use cash as collateral

  22. Alternative 3 Borrow CAD to buy USD on April 1 and invest US dollars for 6 months Deposit USD with 1.65% interest rate USD needed to deposit is $59,026,069.85 CAD$ at 2.7% interest plus principal= $96,252,419.40 Difficult to explain the interest payment for accounting purposes

  23. Alternative 4 Call option to purchase USD that expires in 6 months April 30, 2009 rate = 0.8333 Premium cost = USD $2,285,000 3.8% of USD $60,000,000 Assuming 3% money market rate for 2002 3% annual yield = 1.5% for 6 months 3.8% - 1.5% = 2.3% Real Cost

  24. Alternative 4 (Cont.) Strike Price = 0.8333 Breakeven = 0.8529 CAD needs to appreciate by 2.4% to breakeven 0.8529 – 0.8333 = 0.0196/0.8333 = 2.4% Using 0.60 rate, CAD would only need to increase to 0.614 to breakeven Strike Price < Spot Rate = Profit (In-the-money)

  25. Evaluating Alternatives

  26. Expectations • CAD is considered as a commodity currency closely tied to crude oil • More uncertainties • US has engaged war with the Middle East • US economy expected to weaken • USD less in demand

  27. Outcome

  28. Recommendation Forward contract Need Call Option premium cost on 4/1/02 to determine if Alternative 4 would be better If making a decision today, Alternative 4 would be the best recommendation

  29. Additional Recommendations • Implement FX risk sharing strategy with suppliers • Set up a multi-currency account to purchase and hold USD • Offer travel packages to Europe and Japan • Management should take Dr. Greco’s FIN 570 class

  30. Conclusion • Currency forecasting has many variables and has certain unpredictable elements • Firms NEED to have FX hedging strategy in placed • Can not only rely on quantitative analysis • Always consider micro and macro factors

  31. Questions?

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