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Voyages Soleil The Hedging Decision Case Solution
Jacques Dupuis, president, and owner of Voyages Soleil, a tour operator in Canada, faces the problem of a foreign exchange rate risk. An amount of US$60 million is payable at the end of six months; whereas, the sales for the company, which are mostly in Canadian dollars, are not generated before the end of five months. Dupuis has some alternatives; wait till the end of the six months and pray that the Canadian dollar does not fall much in value; hedge the risk by employing a forward contract; or borrow Canadian dollars now, exchange them to US dollars and invest them till the payment is due. After an extensive qualitative and quantitative analysis, it is concluded that Dupuis should go for a forward contract as it minimizes the risk, ensures payment, mitigates uncertainty and is almost the best option quantitatively, as well.
Following questions are answered in this case study solution
Please identify the problem being faced by the president of Voyages Soleil (VS), Jacques Dupuis.
Please list several specific alternatives that Dupuis can consider.
As an advisor to Dupuis, what would you suggest that he do regarding the foreign exchange risk associated with this contract?
Case Analysis for Voyages Soleil The Hedging Decision
1. Please identify the problem being faced by the president of Voyages Soleil (VS), Jacques Dupuis.
Voyages Soleil (VS) is a tour operator based in Quebec, Canada that provides travel packages including air travel and a stay at a resort in various destinations around South America. Jacques Dupuis, the president, and owner of VS faced a foreign exchange problem in March 2002. The company made advance reservations of rooms in the prospective hotels on April 1, 2002. The payment for these reservations was to be made by October 1, 2002, in US dollars. Although the industry had seen a decline in sales volume after the September 11, 2001 (9/11) attacks, Dupuis had reserved a slightly larger number of rooms this year than the previous year. This was mainly because Dupuis was expecting the tour industry to return to pre-9/11 levels of sales and did not want to run out of hotel rooms this season. Hence, a total of US$60 million was to be paid by VS to different hotels. As the company was based in Canada, with sale receipts in Canadian dollars, Dupuis had to face this foreign exchange rate risk.
There were three major issues that Dupuis had to face when making this decision. First, VS had to print brochures and hence decide prices by April 2002; whereas, customers would start booking their tours from September and would book as late as January 2003. The company probably would not be able to collect enough cash in sales to be able to meet its foreign exchange obligation. Second, the Canadian dollar was constantly declining in value over the past decade which meant VS would probably need more Canadian dollars in October than it did now. Currently, the exchange rate was 0.6298 US$/Cdn$, which made the US$60 million cost over Cdn$95 million. If this rate were to fall to 0.6 US$/Cdn$; for example, the payable would then cost Cdn$100 million. Third, to consider the exchange rate, Dupuis had considered both the US and Canadian economies but was unable to withdraw favorable conclusions. Both the economies had a steady, positive GDP growth rate and a declining interest rate. Analysts, based on economic conditions, could not conclude whether the Canadian dollar was going to strengthen or weaken. On the contrary, the US dollar, in the short-term was believed to be hurt by corporate scandals and in the long-term by the current account deficit. However, the US dollar was expected to remain at its current levels due to an increase in productivity. Hence, the foreign exchange rate risk had become a serious problem for VS and its owner, Dupuis.
2. Please list several specific alternatives that Dupuis can consider.
There are three specific alternatives that Jacques Dupuis can consider in order to minimize the foreign exchange rate risk faced by his company.
Dupuis could choose to do nothing right now and wait till October to exchange the Canadian dollars into US dollars at the rate prevailing at that time. As the analysts had failed to predict the value of the Canadian dollar, the exchange rate, which was currently 0.6298 US$/Cdn$ could go up, fall down or remain the same. This would be considered a risky alternative as it would involve a lot of uncertainty and there would be no effort on the part of Dupuis to hedge or minimize the risk.
Dupuis could employ forward contracts for all of his payables right now, which would lock the exchange rate now and the payment would have to be made later. A forward contract is a non-standardized contract between two parties that agree to buy/sell a specified asset at a specified future time at a price agreed today. The current six-month forward rate for contracts buying up to US$100 million was 0.6271 US$/Cdn$. This means that the contract will ensure that the buyer agrees to buy the Canadian dollars in October 2002 at the specified foreign exchange rate, no matter what the exchange rate should be at the time of the transaction. This contract would basically lock the number of Canadian dollars that Dupuis requires at the time the payable is due which would be approximately Cdn$95.68 million given that the forward rate holds. This is slightly more than the Canadian dollars he requires if he were to exchange the dollars at the prevailing exchange rate. Hence, this alternative is less risky but there is the potential to pay a little extra.
The final alternative available to Dupuis is to borrow Canadian dollars now, exchange them for US dollars at the prevailing foreign exchange rate, invest the US dollars in the US market at the Eurodollar six-month interest rate, and pay off the Canadian dollars’ loan with the payments from sales that would be available for the hotel payments. This is a lengthy process and requires careful considerations and calculations.
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