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

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

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

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

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

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

Market Conditions

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

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

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)

Timeline

10/02 – 01/03

Basic Issues

Importance

UrgencyLow

Low

High

High

Economic Conditions

Foreign Exchange Risk

Competition

Supplier Relationships

Immediate Issues

Importance

UrgencyLow

Low

High

High Wait or Make a Bet?

Forecasted Demand

Pricing

Products

Cause and Effect

Threat to Short-term Profitability

Decrease in Product Demand

Lack of FX Hedging Strategy

Industry Instability

Economic Slowdown

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)

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

Alternatives

1. Wait and use the spot rate at the time payables are due

2. Forward contract 6-month

3. Borrow CAD to purchase USD and invest USD for 6 months

4. Call option to purchase USD with a 6-month expiration

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

March 2002 US Canada

Interest rate 4.75% 3.75%

Inflation rate 1.1456% 1.8538%

Method Formula Projected rate

IFE 0.6328

PPP 0.6276

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Alternative 1

Do nothing, exchange Canadian dollars in October

Rate used X-rate Amount (CAD$)

Case 0.6000 $100,000,000.00

IFE 0.6328 $94,816,687.74

PPP 0.6276 $95,602,294.46

Actual Oct. 1, 2002 0.6305 $95,162,569.39

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

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

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

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)

Evaluating Alternatives

Do Nothing $95,162,569 Too much risk Unpredictable

Best result on 10/1/02

Forward $95,678,520 Locked in contractNeed LOC

Safe bet with certaintyBetter than #3

Borrowing USD

$96,252,419 Too costly & less savings than #2Accounting

Call Option Unknown Flexible Profitable

Possible best option

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

Outcome

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

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

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

Questions?