Case Study of International Financial Management

Nike, Inc. ( Part-2 )

 “International Financial Transactions”

Since Nike has international business in numerous countries, it closely monitors exchange rate movements. In particular, Nike has major business in Japan and in the United Kingdom. It has even begun to sell its shoes in Eastern European countries. Nike recognizes that it must monitor movements in currencies that were not allowed to fluctuate in the past. It has also recently expanded its business in Latin America, where currencies can be quite volatile.

Nike uses currency derivative contracts to hedge some future transactions that are denominated in foreign currencies. Nike’s policy is to use currency derivatives for hedging and not for speculating in foreign exchange market. In general, Nike uses forward contracts to hedge payables or receivables but purchases currency options to hedge some anticipated foreign transactions that are not confirmed commitments. Its hedged transactions are typically denominated in European currencies, the Japanese Yen, or Canadian Dollar. Nike mentions in a recent annual report that the estimated fair market values of its currency derivative positions will fluctuate over time, and that these values should not be assessed by themselves but in relation to the market values of the transactions that are to be hedged. For example, consider a purchase of Yen future contracts by Nike that is intended to hedge future yen payments. The market value of a purchased futures position in Yen could lose market value due to a decline in the Yen’s value. Yet, the dollar market value of the hedged position would decline by a similar amount. Thus, a reduction in the value of any currency derivative positions does not necessarily create more risk because there may be an offsetting effect when the currency derivatives are used to hedge future transactions.

Nike, Inc. needs to order supplies two months ahead of the delivery date. It is considering an order from a Japanese supplier that requires a payment of 12.5 million yen payable as of the delivery date. Its choices are to either:

1^st. Purchase Two Call Options contracts ( since each option  contract represents 6,250,000 yen), or

2^nd. Purchase one Forward contract (which represents 12.5 million Yen)

The forward price on Yen has historically exhibited a slight discount from the existing spot rate. However, the firm would like to use currency options to hedge payables in Japanese Yen for transactions 2 (two) months in advance. Nike, Inc. would like to use an exercise price that is about 5 percent above the existing spot rate to ensure that Nike will have to pay no more than 5 percent above the existing spot rate for a transaction two months beyond its order date, as long as the option premium is no more than 1.6 percent of the price it would have to pay per unit when exercising the option.

A recent event caused more uncertainty about the Yen’s future value, although it did not affect the spot rate or the forward or futures rate of the yen. Specifically, the Yen’s spot rate was still $ 0.0072, but the option premium for a call option with an exercise price of $ 0.00756 was now $ 0.0001512.

The table below summarizes the Option and Forward information available to the firm:

	Before Event	After Event
Spot Rate	$ 0.0072	$ 0.0072
Option Information:
Exercise Price	$ 0.00756	$ 0.00792
Exercise Price (% Above Spot)	5%	10%
Option premium	1.5%	1.5%
Forward Information:
Forward Price	$ 0.006912	$ 0.006912

As an analyst for Nike, Inc. You have been asked to offer insight on how to hedge.

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