Westwood Plastic Case

Westwood Plastic Case

1. The Direction of The Currency

The Canadian dollar (CAD) has experienced a series of fluctuations over the past years, as a result of the domestic and international events.

From a chart perspective, there is evidence that CAD rose from 1999-2006. In 1999, it was at a rate of CAD 1.7615, which was quite weak, but as the years passed the rates kept on appreciating to CAD 1.30 and CAD 1.315 in 2000 and 2001 respectively. In 2004, the currency fell from CAD 1.41 to CAD 1.67, which was negative as compared to its previous high.

Broadly, we think that the appreciated currency rate in 2006 at CAD 1.3536, which is a rise from its low rate in 2004 at CAD 1.67 in just two years, the Canadian dollar would go up as there is an expected rise in interest rate by the Bank of Canada which can definitely increase the demand for the Canadian dollar and this can thereby strengthen the Canadian dollar even more against the Euro.

The speculation of a rise in borrowing cost increased the demand for the currency to a 14-year high. Under these circumstances, we expect that growth will remain relatively slow or within range its at now in the coming year.

2. The Impact of the exchange issue

Because Westwood Plastics Inc. entered into a license agreement with Germany for seeking foreign competition, the company needs to pay for most of its expenses in EURO. As result of this agreement, Westwood is exposed to significant foreign exchange risk.

The domestic and international events were creating unprecedented levels of volatility in currency markets. Meanwhile, the volatility of the currency has an impact on the company’s operation. Between 1999 and 2006, the exchange of CAD to EUR showed great fluctuations from 1.7615 CAD per 1 EUR to 1.3536 CAD to 1 EUR. At the same time, the volatility will alter Westwood’s future expenses that would be paid in Euros. During the period of loan, it is certainly ideal if the exchange rate changed with an equal piece change so that no variation exists. If Canadian dollar appreciates, Westwood’s expense will decrease so that they can make more profit to meet the loan covenant. On the other hand, if the Canadian dollar declines, Westwood’s cost will increase and this would limit their profit and make it impossible to meet the projected income target. Although the Canadian dollar showed strengthening when Westwood entered into the license, the expense in the future would influence Westwood’s profit a lot. Therefore, Westwood has to evaluate the risk and counteract their currency exposure through hedging vehicles.

3.Westwood Plastic Case—Why we choose the Call Option

(1) Westwood needs hedging vehicles to keep profit (EBT).

Hedging vehicles include call option, put option and forward contract.

*Using the standard exchange rate (i.e. 1.3536) to compare other CAD dollar at 1.3336, 1.3736, 1.3936 and 1.4136 without the use of a hedging strategy. If the Westwood want to keep EBT at least at CAD $9 million, it allows the greatest currency exchange rate is 1.4365.

Data from Exhibit 3: [pic 1]

Max EUR COST is $53002= $62002 - $$9000,