EXECUTIVE SUMMARY

This report focuses on the financial decision-making by USASuperCars that sells

luxury sports car. The company has signed a contract to deliver a specific number of
cars to different customers worldwide. The report first finds out the mean of an
uncertain revenue along with the standard deviation of total revenue. The report also
finds out the financial risks faced by USASuperCars. Then, the decision is made on
whether the sure sum to be received by USASuperCars from HSBC Bank is
financially beneficial or risky. It should also be noted that there is an uncertainty in
the exchange rates and therefore, the revenue will vary which depends on the
exchange rate variations either positive or negative. Nevertheless, USASuperCarss
expected return is more than the sure sum but this can be a better option for the
company as the exchange rate risks are unpredictable. It costs them 1.95% to
accept the sure sum offer. I think that the sure sum offer can be the better option for
them since they do not have to pay any interest expense. But if the exchange rate is
the same as the prevailing one then the USA supercars will bear a loss of $44683.2.
This analysis is done throughout the report and then the conclusion is made at the
end of the report confirming my opinion about that.

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Table of Contents
EXECUTIVE SUMMARY .................................................................................................................... 1
INTRODUCTION .................................................................................................................................. 3
DEMAND AND SUPPLY OF LUXURIOUS CARS......................................................................... 4
EXCHANGE RATE UNCERTAINTY ................................................................................................ 5
DATA ANALYSIS ................................................................................................................................ 5
CONCLUSION ...................................................................................................................................... 9
BIBLIOGRAPHY ................................................................................................................................ 11
APPENDICES..................................................................................................................................... 13


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INTRODUCTION
In todays world, the production and consumption of goods has attained the global
status (IISD, 2009). This means that the goods are purchased and consumed by
international customers. This is the reason why such companies are making
relentless efforts to promote their products, services and brands. They find different
ways to lower the cost of sales in order to increase the gross profit that is highly
recommended to be favourable for any company. However, there is a risk for such
multinational companies which is specified by the name of exchange rate risk .If the
exchange rate goes down then there is a need to either put a quota on the number of
goods being exported or stop the exporting of goods. Therefore, it can be said that
the fluctuation in an exchange rate can either increase profits or result in losses.
Moreover, if the $ weakens against other currencies then this will cause the profits of
the deposited money to decline in accordance with other currencies. That is why
hedging is a necessary strategy which lowers the possible risk of losing the value of
invested or deposited money. Hedging involves purchasing forward contracts,
participating in foreign currency swaps, exchanging local currency with foreign
currency and buying of spot contracts (Knight, 2012). Apart from that, foreign
exchange risk can also be avoided by opening accounts in different banks worldwide
where the receivables are paid in the same currency (Reed, 2012). There should be
another option for the manufacturing companies to transfer the base of manufacturer
so that the revenue is received in the similar currency (Anon., 2010). This is the best
possible alternative to avoid exchange rate currency risk. These ways will prevent
the company from exchange rate risk. Moreover, the spot contracts will be of
practical importance to those who are certain of the exchange rate risk. This contract
will involve buying of the securities at the current price and the sell it according to the
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agreement at the specified time and price (Anon., 2009). This will hedge the
company from an exchange rate risk. The buying of a future contract is also
beneficial as it locks the price of the commodity at the specified future price to hedge
against the exchange rate risk (Saefong, 2012).
DEMAND AND SUPPLY OF LUXURIOUS CARS
The car market is gaining popularity due to super luxurious car models like
Lamborghini, Saleen S5S Raptor, Mach7 Falcon, Mosler MT900, HTT Plethore LC-
750, Ford GT etc. (Vijayenthiran, 2011). The characteristics of these cars can be
known through their names. However, as the global economy breakdown occurred in
2008, this lowered the demand for such luxurious sports cars. The situation further
deteriorated with the outbreak of another global economic breakdown during 2010.
This included the event of European Debt Crisis (Voss, 2011). However, USA
Supercars should not look for selling their cars in the foreign market because the
exchange rate is uncertain and it can be favourable and unfavourable on different
occasions that cannot be considered beneficial for any company like USA
Supercars. More than that, they should focus on generating profit from the domestic
currency because there is no uncertainty in the domestic currency. As USA
Supercars has one customer from USA which has a certain revenue without any risk
or danger of exchange rate uncertainty. Therefore, there should be only one
possibility to let the demand and supply increase in the domestic market but the
sales should be made to the foreign market only when the exchange rate is
favourable. Even if the demand increases worldwide for such luxurious cars, then
there is a possibility of an exchange rate risk which will definitely benefit the
customers in some way as if their currency strengthens against US $ then the
revenue will decrease for USA supercars. However, the revenue can increase under
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one condition if the sale is being made to many different customers worldwide and to
domestic customers also.
EXCHANGE RATE UNCERTAINTY
The Bank of America provides the data for exchange rate so that the decision can be
made regarding the selling of luxury cars to the foreign market. Nevertheless, the
company should not give the only priority to the data provided. However, the Bank
has taken every possible variable to calculate the exchange rate between US and
other countries where the sale is yet to be made. It is also necessary to take
necessary steps for domestic promotion. This would be favourable for the company
because only economic breakdown can prevent the company from generating
profits. Hence, it is therefore necessary for the company to promote their products to
sell them to domestic customers in order to increase their CERTAIN revenue. The
word UNCERTAIN revenue creates a havoc for the future as the future exchange
rate is unpredictable and the prediction cannot be done based on economic activities
and indicators (Du & Zhu, 2001).
DATA ANALYSIS
The table in an appendices show the data of seven customers for USA Supercars.
The selling price is in the local currency of the respective country zones and the
exchange rates provided by the Bank of America are estimated on a 1-year basis i.e.
12 months from now. The data is normally distributed and independent. From the
data, it can be revealed that Japan has a lower revenue due to its mean and
standard deviation provided. This increases the risk for selling to Japanese market.
The chart in an appendices show that the highest average revenue return is from the
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12 quantities of supercars by customers of UK. The total mean for an uncertain
revenue is $2192868 whereas the standard deviation for the company is $44668.32.

Standard Deviation
1995258987.76
(=((57000*0.041)^2*12^2)+((8500000*5+9000000*3)^2*0.00045^2)+((97000*1+100000*3)^2*0.03
42^2)+((4100000*0.00083)^2*2^2))
Square root (1995258987.76)
44668.3220
The second question deals with the possible revenues probability. The first condition
to deal with is the probability of revenue exceeding by $2,200,000. By looking at the
z-score table in appendices, the probability is 0.4364 or 43.64%. The second
condition deals with the probability of revenue exceeding by $2,225,000. By looking
at the Z score table, the probability for this condition is 0.2358. The third question
deals with the first condition of probability of the revenue being less than 2,150,000.
The probability for this condition is 0.1685 or 16.85%. The second condition deals
with the probability of the revenue being less than $2,120,000. The probability for
this condition is 0.0516 or 5.16%. The figure for standard normal distributions are
shown in appendices.
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The fourth question deals with decision-making on accepting an offer from HSBC-an
international bank. HSBC offers to pay a specific sum of $2,150,000 in return for the
revenue calculated from the selling of luxury cars to seven customers worldwide. It
can be said that this sure sum is $44668 less than the calculated revenue. The
decision to accept this offer will cost them 1.95% of the revenue in local currency.
Nevertheless, the sure sum offer is certain and there will be no effect on this sum
even if there is a high exchange rate risk. I personally think that USA supercars
should accept the offer because they sum is certain in the local currency.
The fifth question deals with the risk averse investor. The sales manager is willing to
accept the offer from an international bank but the CEO of the company is not
satisfied with the offer. This means that the sales manager is more risk averse than
the CEO as the sales manager is willing to accept the certain sum from the bank but
the CEO is not satisfied with the offer as it is $42868 less than the uncertain
revenue. This shows that the sales manager is more conservative as he knows that
this amount will be compensated if exchange rate risk occurs due to economic
disruptions.
The bank is possibly taking an interest rate risk other than the exchange rate risk.
Because the Bank is providing the sure sum without any interest. It must be noticed
that the provided money must be from the deposits of other customers in current or
savings account. If the deposit is from the savings account, then there will some
interest expense to be paid for that account by the bank. Either the bank is certain
about the exchange rate risk that will prove favourable for them or they are taking
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risk to earn more money than the sure sum. However, the current scenario shows
that the bank is taking an interest rate risk.
If the offer is to be paid within 3 months rather than 12 months then this will create a
major difference, as the bank will have to make the payment without interest 9
months early that is neither favourable nor beneficial for them. If the decision is to be
made on what is preferred by both the parties separately, then the bank would prefer
to make the payment in 12 month time since the sure sum is to paid without any
interest. However, the USA Supercars will prefer to receive the payment within 3
months because this will prove more favourable to them since through this there will
a good effect on the Asset section of the balance sheet. They will be able to manage
and enhance their cash flow operations. Their Accounts receivable account will
increase which will generate a positive increase in the value of assets of USA
Supercars.
Now if the USA Supercars accepts the offer from HSBC then there is a certain
probability that the bank will make a loss if the revenue goes down by $2,150,000.
Since the exchange rate is uncertain and unpredictable, it cannot be said that the
revenue received at the prevailing exchange rates will be the same when the
customers pay the amount. This will depend on exchange rate at the time of
payment made by the customers. However, the probability of the revenue being less
than $2,150,000 is 0.1685. There is 16.8% chance that the revenue will be less than
$2,150,000.
The bank defines it value at risk at fifth percentile of the revenue i.e. 95% confidence
interval. The expected value at risk for the bank is $50326. There is 5% chance that
the bank will lose more than this amount. However, the above expected value at risk
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is just an estimate. The actual calculation will be an accurate value at risk and will be
somehow around it. Whereas, the banks expected profit is $42868 if the prevailing
exchange rates remain the same throughout the 12-month period. If the exchange
rate is not the same as the prevailing ones then the profit can either change into a
loss. This shows that the bank is taking an exchange rate risk. One cannot possibly
predict an exact exchange rate and hence the expected profit is just an assumption
based on prevailing exchange rates.
If the bank does not want to convert all the currencies into US$ then there are
several ways. The bank can spend or save them as a local currency or convert them
into some other needed currency. This will however decrease the risk faced by the
bank. Because as far as less conversion is involved, the risk will be less. This is
because of the exchange rate uncertainty. The risk of exchange rate is high when
the US dollar weakens against other currencies that can generate net loss for the
bank and their sure sum will be a source of their loss.
CONCLUSION
The above analysis shows that the certain revenue other than uncertain revenue is
effective because it can generate a negative outcome for the company. The
company USA supercars has a very good offer to accept from the bank. Both the
parties have 50% chance of attaining a positive return since the word UNCERTAIN
creates uncertainty for accepting the offer. Since the bank provides the exchange
rate data, they must be certain about the deviations in the exchange rates. They
might be certain that there is a high probability of revenue exceeding by $2,150,000.
There can be different views regarding this situation. Nevertheless, if the opposite
happens for the bank, the bank will bear loss from two perspectives. They will bear
loss from interest rate point of view. Since they are providing a sure sum of
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$2,150,000 without any interest being charged to USA supercars. According to me,
the best option would be to prefer the sure sum offer and even prefer the payment to
be made within 3 months to gain a sudden advantage of getting the payment even
less than $44668 is acceptable. They will not have to pay the interest expense for
getting the payment within 3 months. I think that this is the best option for the
company.

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BIBLIOGRAPHY
Anon., 2009. Merk Funds. [Online]
Available at: http://www.merkfunds.com/currency-asset-class/currencies-unplugged/what-is-a-
spot-currency-contract.html
[Accessed 17 November 2013].
Anon., 2010. Agri Xchange. [Online]
Available at: http://agriexchange.apeda.gov.in/Ready%20Reckoner/How_to_Avoid_Exchange.aspx
[Accessed 17 November 2013].
Du, H. & Zhu, Z., 2001. The effect of exchange-rate risk on exports: Some additional empirical
evidence. Journal of Economic Studies, 28(2), pp. 106-121.
IISD, 2009. IISD. [Online]
Available at: http://www.iisd.org/susprod/principles.htm
[Accessed 17 November 2013].
Knight, M., 2012. WikiHow. [Online]
Available at: http://www.wikihow.com/Hedge-Currency
[Accessed 16 November 2013].
Reed, J. T., 2012. US Foreign Exchange. [Online]
Available at: http://www.johntreed.com/are-US-forex-trading-accounts-an-adequate-way-to-hedge-
against-USD-inflation.html
[Accessed 17 November 2013].
Saefong, M. P., 2012. Market Watch. [Online]
Available at: http://www.marketwatch.com/story/how-to-buy-futures
[Accessed 17 Novemeber 2013].
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Vijayenthiran, V., 2011. Motor Authority. [Online]
Available at: http://www.motorauthority.com/news/1054428_americas-mach7-motorsports-
presents-falcon-supercar
[Accessed 17 November 2013].
Voss, J., 2011. Enterprising Investor. [Online]
Available at: http://blogs.cfainstitute.org/investor/2011/11/21/european-sovereign-debt-crisis-
overview-analysis-and-timeline-of-major-events/
[Accessed 17 November 2013].


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APPENDICES


Figure 1 Total Mean of uncertain revenue

Standard Deviation
1995258987.76
Square root (1995258987.76)
44668.3220
(=((57000*0.041)^2*12^2)+((8500000*5+9000000*3)^2*0.00045^2)+((97000*1+100000*3)^2*0.03
42^2)+((4100000*0.00083)^2*2^2))
Figure 2 Calculation for Standard Deviation of total uncertain revenue

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Figure 3 Graph for Mean for different customers


Figure 4 Standard Deviation for USA Supercars customers

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Figure 5 Chart for Standard Deviation USA customers


Figure 6 Illustrative Answer for 2a

Figure 7 Illustrative Answer for 2b

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Figure 8 Illustrative Answer for 3a

Figure 9 Illustrative Answer for 3b = 1-0.95 = 0.0516

ANSWERS TO QUESTIONS
1.
Mean of Total Revenue 2192868 $
Variance of Total Revenue 1995258987.76 $^2
Stdev of Total Revenue 44668.322 $


2. Probabilities
P(X > 2,200,000) = The probability that the revenue will exceed $ 2,200,000 is 0.4364
P(X > 2,225,000) = The probability that the revenue will exceed by $ 2,225,000 is
0.2358
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3. Probabilities
P(X < 2,150,000) = The probability that the revenue will be less than $2,150,000 is
0.1658
P(X < 2,120,000) = The probability that the revenue will be less than $2,120,000 is
0.516
4. The sure sum is a good offer because the revenue is certain. However, it costs 1.95% to USA
supercars to select this option
5. The sales manager is more risk averse because he is willing to get an exact amount of
$2,150,000 but the CEO feels that the company should give more than this amount on the
prevailing exchange rates.
6. The bank is taking an interest rate risk since they will be provide the sure sum without an
interest.
7. If the sure sum is to be paid within 3 months, then USA supercars will receive the amount 9
months early. However, the bank will prefer to pay the amount in 12 month time to avoid
paying the amount without any interest 9 months early. While, the company prefers the
opposite. It will opt for the payment to be made within 3 months.
8. Same as answer to part 3(a)
9. Expected value at risk = $50326
The above value shows that there is 5% that the bank will lose more than this amount and the
expected profit is $42868.
10. Buy some spot price contracts. The bank can also buy forward and future contracts in order to
hedge against exchange rate risk.