Answer to Question #200546 in Management for Zizah

Question

1.Why do you think the firm’s CEO has singled out the currency exchange rate as one of the major factors for the erosion in EPS? 

2.Explain to the CEO the similarities and differences between hedging with options and futures contracts. 

3.Being a producer of CPO, in what situations should Bersatu Plantations Berhad hedges its position? 

4.Is FCPO or FUPO better for Bersatu Plantations Berhad? Explain your answer.

5. Explain why Bersatu Plantations Berhad may experience unfavourable results in hedging compare to non-hedgers from a similar industry.

6. Explain how currency derivatives may be helpful to Mr. Jeratin in dealing with currency valuations. Explain your answer with a specific example.

 

Answer 1

1.According to the Bersatu Plantations Berhad firm’s CEO has singled out the

currency exchange rate as one of the major factors for the erosion in EPS

because of the appreciation of local currency against the U.S. dollar (USD) since

the removal of currency pegging regime.

On July 21, 2005, Bank Negara Malaysia

(BNM), the country’s central bank, announced the end of the peg of Ringgit

Malaysia (RM) to the US dollar immediately after China's announcement of the

end of the RMB peg to the USD. So, removal of currency pegging regime will

result in the appreciation of local currency against the U.S. dollar (USD). So, the

EPS will decrease. This is because exporting crude palm oil (CPO) in the

international market is priced in U.S. dollar (USD). In this situation, we can know

that the appreciation of local currency will no increase the EPS. So, this is the

reason why the company has witnessed a huge increase in CPO sales and has

not translated into the same level of growth in EPS

2.The similarities between hedging with options and futures contracts which both

of the contracts can be used to partially or totally hedge the directional price risk

of an asset. Then, as we know the options can allow for what is known as delta

neutral hedging. Delta neutral is portfolio strategy utilizing and the hedge is an

investment to reduce the risk of adverse price movements in an asset. So, the

delta neutral hedging is which allows a completely hedged position to still profit

should the underlying asset stage a strong breakout in either direction. The

hedging power of options and futures is also extremely important in reducing the

downwards pressure faced by the overall market during market crisis. For

example, institutions which is mutual funds, pension funds, hedge funds, and

private equity firms have large sums of money at their disposal and will

selling

their shares in order to maintain their account value, but by using the options

and future contracts can hedge

downside risk of their holdings.