Alliance Design Case Study

Ruth’s Chris
Memorandum

Date:                February 11, 2019        

To:                Ruth’s Chris.        

From:                Valentine Lang VL

Subject:         International Expansion

Recommendation

The strategy that offers the most benefit to your business is to implement the use of foreign currency options. These will enable Alliance to purchase or sell foreign currency under an agreement that reserves the right but not obligation to execute the transaction at an agreed future date.

Advantages

1. Protects Alliance from downward movements in CAD against USD, while allowing Alliance to profit from upward movements in CAD against USD (Blackman, 2017).
2. Choice of own rate instead of given bank rate. Options are priced off many variables such as time value and volatility. This gives Alliance more freedom to buy/sell a position they are more comfortable with.
3. Doesn’t annoy customer with increased prices or skeptical clauses that could increase the quoted price. The customers are unaware of any anxiety felt by Alliance, and thus will not be scared away by stipulations and tricky contracts.

Disadvantages

1. Monitoring of the position. While downside risk is eliminated, it is important to keep on eye on the position if Alliance would want to profit from the execution of the option.
2. Must pay the premium cost for the trade. Although small, some capital is still used to hedge against the drop in CAD against USD.
3. Doesn’t lock in a future rate, so it is not as simple to forecast accounting because of the unknown rate.

Alternatives
Include a stipulation that final charges to customers would be based on the spot rate at the completion of the project. This option provides less headache for Alliance, as they don’t have to monitor the exchange rate. However, it is possible that it would scare customers away as they might feel like Alliance is acting selfishly, and not in the interest of its customers.

Another option would be to buy forward exchange contracts. These contracts lock in a future rate that Alliance would pay, thus eliminating downside risk. However, the premiums for these are higher than those of currency options, and also provide no upside potential. This is an obligation.